WASHINGTON-Beyond automatic enrollment in 401(k) plans, the Pension Protection Act (PPA) includes a host of provisions that offer fund companies sales opportunities surrounding not how the 2006 law allows individuals to accumulate assets in their working years, but how they distribute those assets later.
With these opportunities, though, come a slew of operational challenges. And while companies and their service providers are looking for further guidance from regulators at the Department of Labor and Internal Revenue Service on many of these technical issues, their marketing departments are preparing to seize on budding business potentials.
"It gives us a chance to talk to financial advisers and prospective shareholders about what these laws mean," Ann E. Plank, product development manager at San Mateo, Calif.-based Franklin Templeton Investments, told attendees of the Investment Company Institute's Pension Protection Act Developments Conference here last Wednesday.
One such conversation fund companies might start with high-income individuals will focus on Roth IRAs. As of 2010, the PPA eliminates the provisions that excluded high-earners from Roth IRAs, which allow tax-free distributions for those aged over 59-1/2.
For fund companies, this provision opens an entirely new, and affluent, marketplace full of individuals likely to contribute the maximum allowed amount to their accounts year after year.
Although clients may not be able to take advantage of this change for three more years, advisers should start to talk to their clients now about what type of distributions-taxable or tax-free-they'd like to take later, said Michael Hadley, assistant counsel at the ICI.
"You have to think ahead," he said.
The PPA also allows these newly eligible Roth clients to convert the distributions from employer-sponsor plans they receive after Dec. 31 of this year. Distributions deposited into a traditional IRA, can now be converted to a Roth plan almost immediately, said W. Thomas Reeder, director of the Office of Tax Analysis at the U.S. Department of the Treasury in Washington.
While it's a popular idea among those trying to control their tax liability, it's a logistical conundrum for IRA administrators, who will have a hard time recouping the cost, said Carol Gransee, assistant vice president for retirement plans at OppenheimerFunds in New York.
"What are you going to do about the annual fee?" she asked. If the distributions convert instantaneously, the plan account is fallow for most of the year, she noted. And while a portion of the taxes go away for the client, the administration costs associated with the conversion, and sheer paperwork of keeping the account open, do not disappear.
Administrators also wait for guidance from regulators about exactly how to code these transactions on year-end reports, she added.
Another important provision of the PPA pertains to how non-spouse beneficiaries receive fund assets after the account holder dies. In the case of employer-sponsored defined contribution plans, especially, plan sponsors, who often subsidize part of the costs of employee's defined contribution plan, want beneficiaries to move their inherited savings out of the program and into an IRA of their own quickly, Plank said.
The PPA allows for such rollovers to be made directly to an IRA, rather than as lump-sum cash distributions, thereby avoiding excise taxes and related penalties.
"From a marketing perspective, one or more children or partners need a place to put the money," she said. Companies that provide them that place by opening an IRA will benefit in the long run, said Plank. "You have a new audience for rollovers."
Beneficiaries who elect to roll those funds into their own IRAs within a year of the death of the account holder can elect to take the distributions annually in amounts calculated based on their life expectancy, Reeder said.
Otherwise, the payment can be rolled into the beneficiary's IRA according to the so-called Five Year Rule, under which any amount distributed in the first five years following the death of the account holder can be rolled into the beneficiary's IRA, but subsequent distributions cannot.
Still, the onus of informing beneficiaries of these rules falls largely on the companies courting their accounts, since the original account holder's provider has no obligation to inform non-spousal beneficiaries, as of now, Reeder noted.
Tax refunds offer another set of opportunities and challenges. The PPA encourages people to save their tax refunds, instead of using them to splurge, by asking Uncle Sam to deposit portions of each refund directly into up to three accounts, including an IRA.
Again, execution poses some obstacles. For one thing, because the custodian receives the money through an electronic transfer, it is sometimes unclear to which tax year the IRA contribution should be applied. As a rule, most firms apply the contribution to the current calendar year, and allow account holders until May, at the latest, to request, in writing, that the deposit be applied instead to the year prior, Plank said.
Once the custodian closes its annual IRA accounting records, though, no changes are allowed, added Gransee, since such changes would expose the custodian to penalties.
Fund companies also sometimes limit the amount they will allow to be deposited from IRS refunds to prevent investors from inadvertently exceeding the allowed contributions for the year, said Reeder. Other companies do not accept tax-refund direct IRA deposits at all. The most common reason for not accepting these tax refunds is a lack of systems to accommodate and properly track them, Plank said.
Finally, the PPA allows those over age 70-1/2 who wish to donate to qualified charities to do so through their IRAs. The advantage for the investor still earning income is that the amount of the distribution donated does not add to the taxpayer's annual reported income. Often, the tax benefits of using an IRA outweigh the 50% deduction allowed for other, non-qualified, income. The provision, which allows for gifts up to $100,000, is set to expire, unless renewed by Congress, after 2007.
To avoid being forced to determine whether charities qualify as eligible, fund companies generally send the checks, made out to the charity of choice, to the account holder, who then forwards it.
Likewise, the designation on Form 1099, reflecting distributions and gains, is left ambiguous, to be clarified by the account holder, Gransee said.
Like many provisions of the sweeping PPA, Plank said, "We still need guidance."
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