In August, President Bush signed the Pension Protection Act of 2006. This act is the most sweeping pension reform legislation passed since ERISA was enacted in 1974. There are significant benefits in this law for dentists. While space won’t allow a complete review, I want to apprise you of some of the planning potential. So, let me share my recent interview with pension attorney Deborah McNear, senior attorney at Krieg DeVault, LLP, in Indianapolis, Ind.
Hufford: Several benefits under the old retirement law had been scheduled to expire in 2011. What does the new law say about these benefits?
McNear: We have become accustomed to the much more liberal provisions in the retirement plan law that were passed in 2001. With the new law, there are several provisions that were made permanent that affect dentistry. The fully phased-in 401(k) contributions of $15,000, plus age 50 “catch up” contributions of $5,000, have been made permanent along with Roth 401(k) contributions. Likewise, the increased contribution limits to IRAs have been made permanent. Increases in maximum defined benefit limits that have allowed older dentists to contribute substantially higher amounts have also been made permanent. Finally, the ability of owners of S Corporations, sole proprietorships, and partnerships to receive plan loans from their retirement plans has become permanent.
Hufford: That’s good news. Many dentists use 401(k) plans. What major changes in the new law affect dental 401(k) plans?
McNear: There are new rules related to “automatic plan enrollment.” Most dental 401(k) plans require participants to elect to defer their money into the plan. Under the automatic plan enrollment rules, a dentist can add a provision to the current plan that automatically enrolls eligible employees and begins withholding for the 401(k) component at a specific percentage of pay. In other words, it is the opposite of the old rules. Instead of electing to contribute to the 401(k), employees in plans with this provision will have to elect not to participate.
Hufford: That sounds complicated and somewhat presumptive of the dentist. Why would a dentist want this provision in the plan?
McNear: It is easy to elect “out” of the withholding by the employee. Perhaps having this automatic enrollment provision will be good because it will encourage younger employees to participate with their own savings. But, for the dentist, there may be advantages in two ways. First, by having this new provision in the plan, a dentist could possibly qualify for lower safe-harbor contributions to pass the ADP/ACP tests. Second, the dentist would be allowed to use two-year vesting of safe-harbor contributions. Under current and continuing safe-harbor 401(k) plans without special automatic enrollment, safe-harbor contributions are immediately vested. So if an employee quits before two years, a safe-harbor contribution will be forfeited.
Hufford: What part of the new law will have the biggest impact on dentistry?
McNear: The new law performs an “extreme make-over” on defined benefit plans. The whole minimum funding structure of this type of plan has been significantly revised. Congress was concerned that many defined benefit plans were underfunded compared with benefits promised to employees. Therefore, some radical new provisions have been added to ensure that plans are properly funded. Many dentists will actually be able to use these provisions to create much larger deductions in their defined benefit plans. For example, dentists will be allowed to contribute and deduct 150 percent of their normal cost under the new law in 2006 and 2007. In 2008, the deduction increases yet again for plans not fully funded. Obviously, this is a major increase. The dentist’s plan will still have to meet the maximum funding limits under Section 415 of the IRS Code.But this new 150 percent provision will allow the dentist to have much larger up-front contributions.
Another change is that the status of “cash balance” plans has been ensured with the new act. These hybrid-type plans now do not violate the Age Discrimination Employment Act as long as certain requirements are met. Many dentists could benefit from pairing this type of plan with their 401(k) arrangement to generate higher deductions.
There is one other major change. Under the old law, only a spouse of a participant was allowed to roll over a lump sum into an IRA account. Under the new law, a non-spouse beneficiary, such as a child, will be allowed to roll over a lump sum distribution to an IRA under the Inherited-IRA rules without paying tax on the distribution. This is a positive change.
