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More savings incentives
The new Roth 401(k), which allows workers to contribute after-tax dollars in exchange for tax-free withdrawals in retirement, is expected to get a much-needed boost from the new law. Employers had been slow to adopt the Roth 401(k), first available this year, for fear it would disappear after 2010. Now that it's permanent, there's no excuse for foot-dragging. The Roth 401(k) is a great option for young workers who will benefit from decades of tax-free growth or for anyone who believes taxes will be higher in the future.
The law also permanently extends the savers tax credit that was due to expire at the end of this year. The credit rewards low-income workers with a tax credit of up to $1,000 ($2,000 for married couples) for contributing to either an IRA or 401(k). Although it can't be used by anyone under 18 or who is a full-time student, it can reduce or wipe out the tax bill for entry-level workers or retirees who work part-time.
Taxpayers will also be permitted to designate that their tax refunds be deposited directly into an IRA.
Investment advice
For years, workers have been asking for guidance on how to invest their 401(k) money. Starting next year, they can get specific answers. In one of the law's most controversial provisions, plan providers, including mutual fund companies, will be authorized to offer specific, in-person investment advice. To ensure that the advice is unbiased and in the worker's best interest, it must be based either on computer models or delivered by financial advisers for a flat fee not tied to the investment products they recommend.
In response to the Enron disaster, the new law also requires companies to allow their employees to diversify out of company stock and into other investments within their retirement plan. EBRI president Dallas Salisbury says the combination of personalized investment advice and liberalized rules on company stock should go a long way toward reducing the high concentration of stock held by some employees -- often well in excess of the 10% normally recommended by financial advisers.
Breaks for beneficiaries
The law also changes some rules on distributions from IRAs and 401(k) plans. Previously, only a surviving spouse could transfer an inherited 401(k) account into an IRA. Other beneficiaries were often required to take immediate distributions that were fully taxable. The new law allows children, grandchildren, siblings and other beneficiaries to transfer an inherited 401(k) to an IRA and stretch out distributions-and taxes-over their lifetime.
But you have to handle the paperwork carefully or risk losing this generous tax break, warns CPA Ed Slott of Rockville Centre, N.Y. Beginning next year, it must be done as a trustee-to-trustee transfer and properly titled as an inherited IRA. You can't roll it over into your own IRA or make annual contributions to it.
There is also a significant, albeit temporary, change for older IRA owners. If you're at least 70½, you can make tax-free distributions from an IRA to a charity in both 2006 and 2007. The donation satisfies rules for required minimum distributions, and donated amounts will not be taxed or included in your adjusted gross income.
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