Gays and lesbians are among those most likely to benefit from particular provisions of the pension reform bill passed by Congress earlier this year. President George W. Bush signed the massive 907-page Pension Protection Act of 2006 into law Aug.17.
The provisions provide tax breaks to non-spousal beneficiaries who inherit a retirement defined contribution plan, a 401 ( k ) or IRA, and allow the owner of the retirement account to tap into it for specified emergencies affecting the beneficiary, without paying a tax penalty. They take effect next year.
Much of the media attention on the legislation has focused on provisions requiring most companies to fully fund their pension programs over seven years, after several plans have gone belly up during bankruptcy reorganization. The airline industry was given a longer period to bring their pensions into compliance.
PRACTICAL IMPACT
Under the previous law, while anyone could inherit a retirement account, only a legal spouse could roll it over into their own retirement fund with no tax penalties. Children or other named beneficiaries who received such an inheritance had it treated as ordinary income.
The large, lump sum payment generally boosted that person's income into a much high tax bracket, and a significant portion of the inheritance would disappear as taxes.
The new 'non-spousal rollover' provision allows the beneficiary to put that inheritance into their own individual retirement account and, for tax purposes, spread it out as income over either five years or on an annual basis for the individual's life expectancy.
The tax implications of spreading out the accounting are to put most individuals into a lower tax bracket and thus pay a smaller total portion of the inheritance as taxes.
HRC presented a hypothetical example of Amy, 61, and Sandy, 63. Amy earns $30,000 a year, which put her in the 15 percent tax bracket. When Sandy died unexpectedly, Amy inherited the $162,000 in her 401 ( k ) plan.
Under the current law, that would be treated as income and bump Amy into the 33 percent tax bracket. Instead of paying federal taxes of $2,980, she would pay $49,360, wiping out about a quarter of the retirement inheritance.
But with the new provisions, Amy could roll that retirement inheritance over into an inheritance IRA. She could choose to deal with the tax burden over five years or over her anticipated life expectancy. Either choice would significantly lower her tax bracket and the total amount she would have to pay in taxes.
Attorney James M. Delafield helped to lobby the bill through Congress. He advises care in choosing either the five year or lifetime option for tax treatment. He cautions, 'It is difficult to change streams once you make a choice.' Each option has its own advantages.
The second key provision, the 'hardship distribution,' allows persons to use retirement savings, without penalty, to meet certain medical or other financial emergencies affecting the beneficiary. Current law allows that to be done only for legally recognized spouses and dependents.
It is particularly important for same-sex couples who are not able to gain such protection and flexibility through marriage.
Delafield said these changes were achieved through bipartisan efforts in the House that included Rob Portman, R-Ohio, now Director of the Office of Management and Budget, and Ben Cardin, D-Md. The provisions 'were viewed as a non-controversial fix.'
Leaders in the Senate included Gordon Smith, R-Ore., Olympia Snowe, R-Maine, Orin Hatch, R-Utah, Ted Kennedy, D-Mass., and Jim Jeffords, I-Vermont.
REACTIONS
'This is an incredibly exciting and momentous victory for the GLBT community and the Human Rights Campaign ( HRC ) ,' said its president, Joe Solmonese. The organization had retained Delafield's firm to work with the bipartisan group of legislators for four years to achieve the results. 'What we really are seeing here, I think, is a huge step toward leveling the field.'
Solmonese said their support for this legislation was not part of a broader strategy to dilute the privileges associated with marriage; 'It was much more an opportunity that we saw to help hard working LGBT families. And we took it.'
David Ratcliffe, national co-leader of the GLBT Professional Network at the financial services company Merrill Lynch, said the company was strongly behind these changes. LGBT Americans 'are faced with another daunting time at retirement.' These provisions 'give us an extra planning strategy in maintaining financial security.'
Both Solmonese and Delafield did not believe that LGBT use of these provisions could be legally challenged as a violation of the federal Defense of Marriage Act ( DOMA ) or state legal and constitutional variations of that act.
Delafield said, 'There is no change to the legal mechanics of what is involved here' with a 401 ( k ) plan. 'It is a rule of general application under the pension law. ... Today, you can list anybody you want as the beneficiary to receive that 401 ( k ) money, should you die.'
'The key step for the gay or lesbian person to make sure that these provisions apply to them and their partner is to make sure that their domestic partner is listed as their 401 ( k ) beneficiary.'
Lara Schwartz, HRC's legal director, said the pension changes 'do not create a federal status of any kind,' so there should be no conflict with DOMA.
Pensions, or defined benefits plans, continue to shrink as a portion of overall retirement planning, while defined contribution plans, such as IRAs and 401 ( k ) s continue to grow
Delafield said an estimated 45 million Americans are currently working and covered by a 401 ( k ) plan. 'Up to half' have not named a beneficiary.
Ratcliffe added, 'Married people often have defaulted on the spouse being the beneficiary because non-spousal beneficiaries were too onerous for them to entertain.' He believes that these new provisions will give many people reasons to consider naming a non-spouse as a beneficiary.
Solmonese said, 'Our goal now is to get the word out on how these provisions work, so that our community can ensure that their loved ones are covered.'
More information can be found at www.hrc.org/estateplanning. It also may be useful to talk with a financial planner to optimize retirement savings and investment strategies for your particular needs and situation.
