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New law encourages workers to save more: Pension Protection Act lifts retirement account limits, steers people into 401(k)s

September 25, 2006

A major provision of the Pension Protection Act signed into law by President Bush last month encourages companies to register workers for retirement plans without requiring them to "opt in."

Putting the onus on employees to decline enrollment is a savings caveat financial planners favor.

"Anytime you leave it up to somebody to do something on their own, you increase the odds that it's not going to happen," said Grace Worley, president of Indianapolisbased Worley Financial Group. "If they're [enrolled] automatically, they have to take some action to stop it, and that's less likely to happen."

Indeed, roughly 30 percent of employees who qualify to participate in a 401(k) plan don't, according to the Profit Sharing/401k Council of America in Chicago. And those who do participate don't come close to putting away the maximum allowed by the IRS.

At last count, plan participants on average socked away $3,512 annually, according to the council, far below the $15,000 maximum allowed under the new pension reform law.

The amount has steadily increased from $11,000 in 2001 and was scheduled to revert to the former limit in 2010, had the legislation not been signed. For workers age 50 and older, a catch-up provision allows them to contribute up to $20,000 each year in their 401(k) plans.

But for the working youth, planning for retirement often is an afterthought. In fact, the Profit Sharing Council said most employees who don't participate in plans are those under age 35 who don't think they can afford to.

Pat Burley, president and CEO of Carmel-based Meridian Investment Advisors, concurred.

"People don't really have a tendency to think about [saving] when they're younger," he said. "They're out partying and buying beer at Colts games and stuff like that. [Automatic enrollment] is going to get these people to save money."

For automatic enrollment, the law sets the 401(k) base contribution level at no less than 3 percent of an employee's salary starting Jan. 1, 2008. The rate increases 1 percent a year until it reaches 6 percent, or no more than 10 percent.

The 401(k) reform may be less appealing to some companies, however, Burley said. Those burdened by high turnover might not want to deal with the administrative hassles of coordinating additional plans, he said.

Automatic enrollment isn't new. In fact, some companies have been doing it for years, but the new federal law overrides any state laws that discourage the practice.

Almost a quarter of large employers automatically enrolled workers in 2005, according to research firm Hewitt Associates, compared with 7 percent that did so in 1999. Nearly 90 percent of employees who are automatically enrolled in 401(k) plans do not opt out.

Roth changes

Besides permanently extending the limits on 401(k) contributions, the act has implications for individual retirement accounts as well.

The maximum annual IRA contribution limit for traditional and Roth IRAs was raised in 2001, but was set to expire in 2010 until the Pension Protection Act made the changes permanent.

The annual limits are set at $4,000, or $5,000 for the over-50 crowd, and will rise by $1,000 in 2008.

Roth IRAs and 401(k)s also have been made permanent. Unlike traditional 401(k)s and IRAs, the money saved into Roth plans is taxed upfront. But the longterm benefit could be well worth the initial loss, because no taxes are owed upon withdrawal at retirement.

Individuals with incomes below $110,000 and married couples filing a joint tax return with income under $160,000 are eligible to fund a Roth IRA.

Folks earning higher salaries, though, may be more excited about the permanency of the Roth 401(k) that was set to expire in 2010.

The Roth 401(k) may appeal to younger employees who are more likely to be hit with a higher tax rate at retirement. If a survey conducted last year by Lincolnshire, Ill.-based Hewitt Associates is any indication, many employees won't get the chance to invest in a Roth 401(k). The global human resources outsourcing and consulting firm reported only 30 percent of the 458 firms surveyed said they are likely to add the benefit to their plans.

Passage of the pension act should prompt more employers to offer the Roth, predicted Michael J. "Mick" Meiners, a certified financial planner and attorney at Financial Plans & Strategies Inc. in Greenwood.

"Now that it's been made permanent, people will look at it from a different perspective," he said. "It's still a relatively new concept. I think it will become more and more popular as time goes by."

Shifting responsibility

The pension act's original intent was to ensure pensions are fully funded in the event a corporation goes bankrupt and sticks taxpayers with the bill. But given that fewer companies offer traditional pension plans, the federal government is giving the public more tools to plan for retirement.

Encouraging workers to sink more of their paychecks into retirement plans is a small part of the larger battle to save Social Security. Bush wants to restructure the program by letting younger workers open private investment accounts. The approach could alleviate a serious cashflow deficit in the years ahead as members of the baby boom generation retire and benefit costs escalate faster than revenue.

The Social Security Administration predicts 79 million baby boomers will begin retiring in 2008. And, in about 30 years, there will be nearly twice as many older Americans as there are today. The age in which workers become eligible for benefits will increase from 65 to 67 for those born after 1959.

Passing part of the responsibility on to the employer could help save the system, said David Wray, president of the 401(k) Council.

"Employers who want to take participation to the next level are recognizing that they have to take action," he said. "The legislation really clears away the barriers, because there were some regulatory concerns."

As for the act in general, there's no disputing the intentions of federal lawmakers, said Chris Halter, an owner of locally based Halter Ferguson Financial Inc.

"The government certainly is making a statement that it wants you to save for your own retirement," she said.
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