401(k)s in maximum overdrive
New pension legislation makes workplace savings easier, smarter and more lucrative.
NEW YORK (CNNMoney.com) -- Parties with a vested interest in your retirement savings - employers, investment firms, employee advocates, you name it - hotly contested most of the provisions in the recently passed Pension Protection Act of 2006.
But most agreed that certain provisions included will greatly improve the size of your 401(k) nest egg, your ability to invest smartly and your chances of walking away with greater matching contributions from your company.
Not all the new provisions are mandated by the legislation. Some are simply encouraged. But companies are likely to adapt many of them in an effort to attract employees and boost worker savings, experts say.
Here's a roundup of 401(k)-related changes that can work to your great advantage if you use them:
The annual contribution limit on 401(k)s - currently $15,000 - is set to increase every year for cost-of-living until 2011, at which point it is scheduled to fall back to approximately $13,000. The new legislation makes permanent the $15,000 level plus annual cost-of-living adjustments.
The difference between contributing $15,000 a year and $13,000 a year can amount to $200,000 over 20 years, assuming an 8 percent average annual return and excluding any matches your employer may give you.
In addition, workers over 50 may contribute an additional $5,000 to their 401(k) accounts on top of the federal contribution limit. The provision was set to expire in 2011, but the new legislation makes it permanent and calls for the catch-up amount to be adjusted for cost of living.
Studies show that 401(k) participation rates rise dramatically when employees are automatically enrolled, meaning a worker has to take action only if he or she doesn't wish to participate in 401(k).
Currently, only about 70 percent of eligible workers participate in their 401(k)s.
The Pension Protection Act encourages employers to put worker inertia to good use by making it easier to automatically enroll eligible employees. It requires them to set the employee's initial contribution rate at no less than 3 percent of pay and increase that amount by one percentage point a year until reaching 6 percent but never more than 10 percent.
The move will benefit workers across the income spectrum.
Low-income workers, for instance, are the least likely to save, so automatic enrollment will help build savings for them that otherwise wouldn't exist.
High-income workers, meanwhile, may be allowed to contribute more than before. Here's why: Employees making more than $95,000 are limited in what they may contribute to a 401(k) plan by the average contribution rate among employees making less.
So if that average goes up - as it does under automatic enrollment because more employees are participating - so will the allowable contribution rate for highly paid employees.
Companies with automatic enrollment don't have to offer employer contributions to 401(k) accounts. But they will have to if they wish to avoid the discrimination testing described above to determine how much highly paid employees may contribute.
To avoid that testing, the legislation requires that employers either:
Contribute 3 percent of salary for non-highly compensated workers eligible for enrollment;
Match 100 percent on the first 1 percent of non-highly compensated workers' contributions plus 50 percent on the next 5 percent.
A number of companies not only match employee contributions in 401(k)s but also offer a profit-sharing contribution - that is, your employer may "share" its profits with all employees by offering stock or cash.
Until now, the matching contributions and the profit-sharing contributions have been subject to different vesting schedules - that is, the length of time you must work at the company before getting to keep 100 percent of the contributions.
The new legislation makes the vesting schedule uniform for both by speeding up the vesting requirements for profit-sharing payouts. As with matching contributions, a company will not be allowed to extend vesting for profit sharing beyond six years if it's done on a gradual basis (e.g., 16.6 percent a year for six years) or three years if it's done all at once (you get to keep 100 percent of the money after three years but none before that).
In the case of plans with automatic enrollment, if the employer wants to avoid discrimination testing, matches must be fully vested after two years of service.
The new law places limits on just how long an employer may insist you keep your money in company stock.
If it makes its matching contribution in stock, you must be allowed to sell it no later than after three years of service.
If you've acquired company stock before the law goes into effect and you've been at a company for three years, you will be allowed to sell a third of it in the first year the law takes effect, another third in the second and the final third in the year after that. But any new stock you receive after the law goes into effect you may sell at any time.
Tax credit for savers
The pension bill makes permanent the saver's credit, otherwise set to expire this year.
The provision allows low-income workers to receive a credit (a dollar-for-dollar reduction of the taxes they owe) for up to 50 percent of their 401(k) contributions up to $2,000.
The tax benefit is twofold: your contribution reduces your gross income, which lowers your tax liability the year you make the contribution, and then the tax credit for that contribution will reduce your tax bill further.
The credit is available to taxpayers with adjusted gross incomes of $25,000 or less (or $50,000 or less if married).
Under the new legislation, the plan provider that your company chooses to administer your 401(k) plan will be allowed to offer you advice about how to invest your money in the plan so long as it does so using a computer model approved by an independent third party.
If the plan administrator is an investment firm - e.g., Fidelity - its representatives are allowed to recommend their own funds that are in the plan, but they may do so only if such funds are in your best interest, since administrators along with employers have a fiduciary duty to act in your best interest.