New pension law affects public-sector, non-profit workers, too
The Pension Protection Act of 2006 has many provisions that will alter government and non-profit retirement plans.
NEW YORK (CNNMoney.com) -- The pension law signed by President Bush last week will have its primary impact on tens of millions of private-sector workers who have defined benefit pension plans and defined contribution plans such as 401(k)s.
But the Pension Protection Act of 2006 also will affect millions of public-sector and non-profit workers with 457 and 403(b) plans, and to a lesser degree, those public-sector workers in state pension plans, in particular policemen and other public safety workers.
The 457 and 403(b) plans are similar to 401(k)s in that workers may contribute pre-tax dollars to their accounts, invest the money in any of the funds available in the plan and their money will grow tax-deferred until retirement, at which point it is taxed as income upon withdrawal.
The pension law made permanent the increased contribution levels not only for 401(k)s but for 403(b)s and 457s as well. For 2006, the maximum contribution allowed is $15,000 and the amount will adjust for inflation every year thereafter.
Also made permanent was the $5,000 catch-up contribution that workers 50 and older may make in addition to the $15,000 annual contribution limit.
And like 401(k) account holders, low-income workers saving money in a 457 or 403(b) plan will be eligible for the saver's credit, which the new pension law makes permanent. The credit (a dollar-for-dollar reduction of your taxes) is worth up to 50 percent of your 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. It also may be directly deposited into your retirement plan rather than be refunded to you if you choose.
The credit is available to taxpayers with adjusted gross incomes of $25,000 or less (or $50,000 or less if married).
In addition, while the new law makes it explicitly easier for 401(k) providers to automatically enroll employees by making clear that federal law will pre-empt state law in the matter, it may also make it easier for 403(b) and 457 plan providers to do the same because Congress has spoken loudly in favor of auto enrollment, said Mark Iwry, a senior adviser to The Retirement Security Project and a senior fellow at the Brookings Institution. (See more on automatic enrollment here.)
Also under the new law, a 401(k), 403(b) or 457 plan provider may opt to expand the circumstances under which a plan participant may make a hardship withdrawal -- which is exempt from early withdrawal penalties. Until now, the option has only been available if a medical crisis or other hardship befalls participants, their opposite-sex spouses and their dependents. The new law would allow that group to be expanded to include domestic partners and non-dependents.
Enhanced benefits for public-safety workers
When it comes to pensions for public-sector workers, the law includes a few provisions that may affect them directly. It does not, however, address funding issues in those plans because public-sector pensions are governed by the states, not the federal government or the Employment Retirement Income Security Act (ERISA), which governs workplace retirement plans in the private sector.
Public safety employees, who often retire earlier than most workers due to the physical rigors of their job, will enjoy an enhanced benefit under the new pension law. Until now, they had pay a 10 percent early withdrawal penalty on pension payments if they retired before age 55. The new law lowers that age to 50. (The withdrawal penalty will still apply, however, if you retire before 50 and defer payment of your pension until after 50, said Larry Wilson, chairperson of the American Academy of Actuaries' Public Plans Task Force.)
Another major change affecting public-sector workers pertains to buying "service credits" to enhance pension payments. The new law provides clarity that public-sector workers are allowed to buy service credits in their state or local pension plan for the years where they either didn't work or took a job with another employer.
So, for example, say a teacher with 20 years of experience spent 15 years in the public school system and five at a parochial school or in the military. And say she needs to have a minimum of 20 years of service in order to collect a pension from the public school system. She now can use her own money to buy service credits in the public-school plan for the five years she spent away. Plus, the new law allows her to buy the credit using money from her 403(b) or 457 plan if she wishes. Once the money is transferred it will be subject to the distribution rules of the pension plan.
Lastly, the new law allows retirees from public service to pay for their healthcare premiums with pre-tax dollars from their pension checks up to $3,000 so long as the money is paid directly to the insurer.