2006 Lane Reports

Pension Protection Act Creates New Opportunities

Friday, September 1, 2006
by Joshua S. Kreitzer

A new Federal law, signed into law with little fanfare last month, has created new opportunities for retirement plan participants, individual retirement account owners, and their beneficiaries, while also having an impact on charitable organizations. The law, known as the Pension Protection Act of 2006, includes a variety of provisions, with some of the most interesting ones being described below.

New Rules on In-Service Distributions

For example, retirement plans which are classified as "pension plans" -- a category including both defined benefit plans and money purchase plans, but not profit sharing plans -- were previously forbidden from making distributions to employees who have not actually retired. Under the new law, by contrast, pension plans will be allowed to make distributions to employees who are at least 62 years old and still working (such distributions are known as "in-service distributions"). This provision will take effect for plan years beginning after December 31, 2006. Note that profit sharing plans are not subject to this new provision -- profit sharing plans continue to be allowed to make in-service distributions to employees who are at least age 59 1/2. Furthermore, regardless of the type of plan, the availability of in-service distributions is governed by the plan's provisions, and employees can only receive such distributions if authorized by the plan's governing document.

IRA Distributions to Charitable Organizations

Another provision in the new law benefits owners of individual retirement accounts ("IRAs"). Normally, distributions from a traditional IRA are subject to income tax in the year they are withdrawn. However, the Pension Protection Act allows certain tax-free distributions in 2006 and 2007 only, provided that the account owner has the IRA trustee make distributions directly to a qualifying charitable organization or organizations. This provision applies only to taxpayers who are at least 70 ˝ years of age, and they are allowed to make such tax-free gifts from their IRAs up to $100,000 in each of the two years. In general, only distributions made to public charities for which a taxpayer can normally deduct contributions up to 50% of adjusted gross income, not including private foundations and donor advised funds, can qualify for such exclusion from income.

IRA owners should take note that they must not receive any benefits from the charity in exchange for such distributions; if they do, the entire amount distributed to the charity will be disqualified from the exclusion from income.

Such distributions count toward the taxpayer's annual required minimum distribution for the year in which they are made; consequently, an IRA owner who is required to take a distribution from his or her IRA, but does not want to, could have the IRA trustee send the distribution amount to a charity instead, thus avoiding tax on the required minimum distribution.

Note that because the proceeds of such an IRA distribution are not treated as taxable income to the IRA owner, the IRA owner cannot also claim a charitable deduction for the funds distributed to the charity - doing so would be "double dipping." Nevertheless, having IRA distributions go directly to a charity, rather than having the owner collect the distribution and then donate the proceeds to charity, would be advantageous to taxpayers who do not itemize deductions; taxpayers who already contribute the maximum deductible amount to charity; taxpayers whose income level causes their exemptions or itemized deductions to be phased out; and taxpayers for whom additional income would increase the amount of their Social Security income subject to tax.

Rollover IRAs for Non-Spouse Beneficiaries

Yet another provision of the Pension Protection Act will be helpful to persons who receive distributions as beneficiaries of a retirement plan of someone who wasn't their spouse. Before the new law, a surviving spouse who received benefits from their deceased spouse's retirement plan could roll over those benefits into an IRA - thus deferring tax on the amounts received until withdrawals were taken from the IRA. Non-spouse beneficiaries did not have that option, meaning that they had to receive the participant's retirement benefits over a shorter amount of time and pay tax on them. Now, however, non-spouse beneficiaries will be able to roll those benefits into an IRA as well, enabling them to defer the tax into the future and ease their tax burden by spreading the income over a longer period of time. This provision will apply beginning January 1, 2007.

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") which made a variety of changes to the tax laws regarding retirement plans and individual retirement accounts (among other changes). For example, EGTRRA increased the maximum combined annual contribution to a traditional IRA and a Roth IRA from the previous amount of $2,000, over time to $4,000 (as it is in 2006), to $5,000 in 2008, with adjustment for inflation beginning in 2009. However, EGTRRA was scheduled to "sunset" on December 31, 2010, with the tax laws it amended going back to what they were before in the year 2011.

The Pension Protection Act has now removed the sunset provisions as to retirement plans and IRAs. Consequently, the inflation adjustment will continue in effect into the future. Similarly, persons over age 50 will continue to be allowed to make "catch-up contributions" to their IRAs; currently, the additional catch-up contribution amount allowed is $1,000 per year.

Catch-up contributions also apply to 401(k) plans. EGTRRA allowed participants who are age 50 or older to make additional contributions to such plans in an amount which was increased each year from 2002 to 2006, now amounting to $5,000 per person per year (or $2,500 for SIMPLE 401(k) plans and SIMPLE IRAs). Thanks to the Pension Protection Act, catch-up contributions will still be permitted in the year 2011 and beyond.

Higher Tax Penalties for Violations by Charitable Organizations

Not all of the provisions of the new law relate to retirement plans and IRAs. In particular, charitable organizations and persons associated with them should take note of the provisions which double the excise taxes applicable to certain activities. For example, self-dealing between a private foundation and a disqualified person (such as a manager of, or substantial contributor to, the foundation) - which would include such practices as sales of property or loans between the private foundation and the disqualified person - previously resulted in a 5% tax on the disqualified person and a 2.5% tax on a foundation manager who knowingly participated in the self-dealing transaction. Now, however, the taxes would be 10% on a disqualified person who engages in self-dealing and 5% on the foundation manager who participates in the transaction. (However, if the transaction is not corrected, the disqualified person is subject to a 200% tax on the transaction and the manager is subject to a 50% tax; these percentages remain unchanged.)

Similarly, if a public charity engages in an "excess benefit transaction" with a disqualified person - such as overpaying for property it purchases from the disqualified person, or paying that person an overinflated salary - a manager of the organization who knowingly participates in the transaction can now be subject to an excise tax up to $20,000 per transaction. Under prior law, the limit was $10,000.

Such increases in excise taxes can serve as a reminder to persons involved with charitable organizations of their duty to avoid conflicts of interest in dealing with the organization.


The Pension Protection Act creates a variety of new possibilities for retirement plan participants and IRA owners, in addition to having effects on retirement plan sponsors and charitable organizations. If you are such a person or involved with such an entity, The Law Offices of Marc J. Lane would like to help you make plans in accordance with this new law. Please call us at (312) 372-1040 or e-mail mlane@marcjlane.com if you'd like to find out what we can do for you.


Joshua S. Kreitzer (B.A., Harvard University; M.A., University of South Florida; and J.D., Northwestern University) is Senior Associate Attorney with The Law Offices of Marc J. Lane, a Professional Corporation.


Send this page to a friend

The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.

Announcing Marc J. Lane's 35th Book:

The Mission-Driven Venture: Business Solutions to the World's Most Vexing Social Problems

More About The Book
Our monthly newsletter