The recently signed Pension Protection Act of 2006 is composed of almost 1,000 pages of text concerning new pension plan rules and retirement tax breaks. A few more prominent features of the new law follow.

 

 

Your company pension plan could be the source of additional compensation to you, but it is up to you to ascertain how to attain this additional compensation. We are referring to the new pension law that does not automatically enroll employees in a company 401(k) plan, but requires employees to request enrollment in the plan.

 

Basically, most 401(k) plans have an employer matching contribution that goes from 3% of salary to 10% of salary, with 6% being the norm. So if you earn $50,000 and contribute 6% or $3,000 to your company 401(k) plan, the company will also contribute $3,000 to the plan. This is like receiving a $3,000 bonus.

 

 

Statistics released by Congress indicate that 30% of eligible employees do not participate in a company sponsored 401(k) plan.

 

One excuse we commonly hear is “that I do not expect to work here very long and I understand that I can’t get my money for 35 years.” Generally this is not the case. When you leave employment you can always “roll over” the 401(k) plan to an IRA, and you can then obtain an early distribution from the IRA.

 

The next excuse is that if I do that I am subject to a 10% penalty. The answer to that is “maybe”. The tax law allows distributions without a penalty if the funds are used for qualified higher education costs, up to $10,000 can be withdrawn without penalty for “first time homeowner expenses”, and the penalty does not apply to the portion of the distribution that represents a return of nondeductible contributions.

 

And if you become subject to the penalty, so what.

 

 

NO. As an example, let’s look at a single person with a $50,000 salary, an employer with a 6% matching contribution plan, with the individual being in the 25% tax bracket. If the individual does not put $3,000 in the company plan they will have $2,250 left after taxes. Assuming no investment income, after 3 years they will have $6,750 cash in pocket.

 

If this individual put $3,000 in the company 401(k) plan with a matching $3,000 from the employer, at the end of 3 years there is $18,000 in the plan (ignoring investment income in the plan). If the individual leaves employment, rolls over the $18,000 to an IRA, and then takes an early distribution, tax and penalty is now due. The income tax will be $4,500 and the penalty $1,800, leaving the individual with cash in pocket of $11,700, which is about 70% more than the $6,750 they would have if they did not participate.

 

So don’t leave money on the table. If your employer has a matching contribution plan, consider contributing the maximum matching amount possible.

 

 

After you maximize the amount of your employers matching contributions to a 401(k) plan, you should consider maximizing your contributions to a Roth IRA if you meet the income qualifications; single, under $110,000 and married filing joint, $160,000. The maximum contribution in 2006 is $4,000 or $5,000 if you are over 50 years of age. While contributions to a Roth IRA are not tax deductible, the distribution you receive on retirement is not subject to income tax.

 

 

There is no doubt that certain charities are primarily funded by the wealthy. And the new pension law gives them another break. In 2006 and 2007 only, an individual can donate $100,000 from their IRA to a public charity without paying any income tax on the distribution from the IRA. In turn, they are not allowed an itemized deduction for the charitable gift.

 

Here is how it works. Under the old law, if you had an IRA distribution of $100,000 you would pay a tax of 35% or $35,000, and if you gave the remaining $65,000 to a charity, you would obtain about a $22,000 tax benefit for the charitable contribution. Under the new law you can give $100,000 directly to the charity from the IRA, pay no income tax, and forego your $22,000 tax benefit.

 

 

In 2003 a new law added a prescription drug benefit to Medicare. Buried in that law was a provision to be phased in between 2007 and 2009 to increase the Medicare premiums for those still working and for those with higher retirement income. In 2007 the standard Medicare premium that is taken from each months social security check is expected to be $98.40 a month, up from $88.50 in 2006.

 

However, the 2003 law, when fully implemented in 2009, calls for those making $80,000 to $100,000 to pay 1.4 times the standard amount. An individual with income in the $100,000 to $150,000 range will pay 2.0 times the standard amount. An individual with income in the $150,000 to $200,000 range will pay 2.6 times the standard amount. An individual with income over $200,000 will pay 3.2 times the standard amount.

 

A recent article on this subject in the New York Times quoted Senator Dianne Feinstein, Democrat of California, as stating “high income beneficiaries can afford to pay a larger share of Medicare’s costs” because Congress cut their taxes. We doubt that Dianne voted “yes” for the tax cuts.

  

 They Get You Again When You Do Not Pay Attention

 

Timely filing of Federal tax returns by US citizens living abroad has always been a problem. Each year we do work for a dozen or so individuals who have not filed for numerous years. Many of these individuals owe either a small amount of tax, or no tax. As the IRS does not impose a penalty on late filed returns with no tax due or a refund due, many individuals in this circumstance are casual about the timely filing of their tax returns.

 

However, a little known provision of the tax law can create a big problem for non filers. As an example, suppose you did not file your 2001 tax return for which you expected a $15,000 tax refund, and you also did not file your 2002, 2003 and 2004 Federal tax returns where you expected to pay a tax of about $4,000 each year. Most individuals would expect to receive a $3,000 refund if all of these tax returns were filed in 2006.

 

In the above example, the individual actually owes the IRS $12,000 in income tax, $3,000 in penalties for late filing, and about $2,500 in interest for late payment and underpayment of tax.

 

How can this be? The administrative section of the Internal Revenue Code states that if a tax return requesting a refund is not filed within 3 years of the due date, the IRS gets to keep the refund. So as the 2001 tax return was due to be filed in 2002, when it wasn’t filed in 2005, the refund reverted to the IRS.

 

The moral is that if you have a tax refund coming timely file your tax return.

 

 

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own U.S. tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.