In This Issue:
Legislative Changes Made in 2001 Affecting Qualified Retirement Plans
In June of this year, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"). This new law makes several changes that affect employer-sponsored retirement plans. Most of these changes are favorable to plan sponsors and individuals. In addition, many of the changes are either effective in 2002 or are phased-in beginning in 2002.For your convenient reference, we have briefly summarized the key legislative changes that affect qualified retirement plans on the attached list. While many of the changes are optional, a plan sponsor that chooses to implement an optional provision of EGTRRA will have to amend its plan to conform plan provisions to plan operation. Further, while many of the changes need not be adopted until the end of the 2002 plan year, earlier adoption may be necessary in order to avoid a decrease or elimination of benefits protected by law.
That Generally Affect All Retirement Plans—Miscellaneous Compensation Limit Increased
The annual compensation limit will increase to $200,000 in 2002. This dollar amount is indexed for inflation in $5,000 increments after 2002. (This change is effective for years beginning after December 31, 2001.)
Plan Loans Available for S Corporation Shareholders, Partners, and Sole Proprietors
S corporation shareholders, partners, and sole proprietors will be permitted to obtain participant loans under the same circumstances as other plan participants. (This change is effective for years beginning after December 31, 2001.)
Disclosure of Plan Amendments Reducing the Rate of Future Benefit Accruals
In the event a defined benefit plan or a money purchase pension plan (other than governmental plans and nonelecting church plans) is amended to provide for a significant reduction in the rate of future benefit accruals, including amendments that eliminate or reduce an early retirement benefit or retirement-type subsidy, the plan administrator is required to provide an understandable written notice to each participant in the plan and each alternate payee within a "reasonable time" before the effective date of the amendment. (This change to ERISA and the new provision in the Internal Revenue Code applies to plan amendments, which are effective on or after June 7, 2001.)
Changes That Generally Affect Portability (Rollovers)
Rollover Contributions Disregarded for Purposes of Cash-Out Rules
For purposes of the cash-out rule, a plan is permitted to provide that the present value of a participant’s nonforfeitable accrued benefit is determined without regard to the portion of such benefit that is attributable to rollover contributions (and any earnings thereon). (This change is effective for distributions made after December 31, 2001.)
Rollovers Permitted from IRAs to Qualified Plans and 403(b) Annuities
Distributions from an individual retirement account (IRA) are permitted to be rolled-over into a qualified plan or 403(b) annuity regardless of whether the distributing IRA qualifies as a conduit IRA. (This change is effective for distributions made after December 31, 2001.)
Rollover of After-Tax Contributions
Employee after-tax contributions may be rolled over into another qualified plan or a traditional IRA. After-tax contributions (including nondeductible contributions to an IRA), however, are not permitted to be rolled-over from an IRA into a qualified plan or 403(b) annuity. A qualified plan is not permitted to accept rollovers of after-tax contributions unless the plan provides separate accounting for such contributions (and earnings thereon). (This change is effective for distributions made after December 31, 2001.)
Hardship Distributions No Longer Eligible Rollover Distributions
No hardship distribution will qualify as an eligible rollover distribution. Accordingly, such distributions may not be rolled over and are subject to the withholding rules applicable to distributions that are not eligible rollover distributions. (This change is effective for distributions made after December 31, 2001.)
Rollovers Between 403(b) Annuities and Other Qualified Plans Allowed
An employee participating in a 403(b) annuity may roll over an eligible rollover distribution tax free to a qualified plan. In addition, eligible rollover distributions from a qualified plan may be rolled over tax free to a 403(b) annuity. (This change is effective for distributions made after December 31, 2001.)
Changes That Generally Affect Only Defined Contribution Plans
Maximum Annual Addition Limit for Defined Contribution Plans Increased
The annual addition limit for defined contribution plans will increase to the lesser of $40,000 or 100% of a participant’s compensation. The $40,000 amount is indexed for inflation in $1,000 increments. (This change is effective for years beginning after December 31, 2001.)
Deduction Limit for Contributions to Profit Sharing and Stock Bonus Plans Increased
The annual limitation on the amount of deductible employer contributions to a profit sharing plan or a stock bonus plan will increase from 15% to 25% of the compensation of the employees covered by the plan for the year. For purposes of the deduction rules, the definition of "compensation "includes all employee elective deferrals to a 401(k) plan and a 403(b) annuity and amounts contributed on behalf of an employee to a section 125 cafeteria plan. (This change is effective for years beginning after December 31, 2001.)
Modification to or Elimination of Optional Forms of Benefit.
A defined contribution plan may transfer a participant’s benefits to another defined contribution plan, even if the receiving plan does not offer all of the forms of distribution previously available under the prior plan if certain requirements are satisfied. In addition, the IRS is directed to issue regulations that will allow plan amendments that reduce or eliminate early retirement benefits, retirement-type subsidies, and optional forms of benefit, but only where such amendments do not adversely affect the rights of any participant in more than a de minimis way. Finally, except to the extent provided in Treasury regulations, a defined contribution plan is not treated as reducing a participant’s accrued benefit if a plan amendment eliminates a form of distribution previously available under the plan. A single sum distribution must, however, be available to the participant at the same time or times as the form of distribution being eliminated and the single-sum distribution must be based on the same or greater portion of the participant’s account as the form of distribution being eliminated. (This change is effective for years beginning after December 31, 2001.)
Changes That Generally Affect Only 401(k) Plans and 403(b) Annuities
Faster Vesting of Employer Matching Contributions
Employer matching contributions will be required to vest under a faster vesting schedule (i.e., either 100% vesting after three years of service or 20% vesting per year beginning after two years of service). In applying the new vesting schedule, service before the effective date is taken into account. This change does not, however, affect most church plans or governmental plans (i.e., employer matching contributions can vest under the vesting schedule currently in effect). (This change is effective for matching contributions made for plan years beginning after December 31, 2001, with a delayed effective date for plans maintained pursuant to a collective bargaining agreement.)
Dollar Limit on Annual Elective Deferrals Increased
The dollar limit on annual elective deferrals to 401(k) plans and 403(b) annuities will increase to $11,000 for calendar year 2002. The applicable dollar amount is $12,000 for 2003, $13,000 for 2004, $14,000 for 2005, and $15,000 for2006. In addition, the dollar limit on annual elective deferrals will be indexed for inflation in $500increments for taxable years beginning after December 31, 2006. (This change is effective for years beginning after December 31, 2001.)
Additional Elective Deferral "Catch-up" Contributions for Participants Age 50 and Older
A 401(k) plan or a 403(b) annuity may now permit participants who have attained age 50 before the end of the plan year to defer amounts in excess of the dollar limit on annual pretax elective deferrals as long as they have first maximized their elective deferrals allowed under the plan or the law. The applicable catch-up dollar amount is $1,000 for 2002, $2,000 for 2003, $3,000 for 2004, $4,000 for2005, and $5,000 for 2006 and thereafter. The $5,000 "catch-up" contribution is adjusted in $500increments beginning in 2007 and thereafter. These additional "catch-up" contributions are not subject to applicable nondiscrimination rules as long as all participants over age 50 are allowed to make "catch-up" contributions. In addition, "catch-up" contributions are not subject to the maximum annual addition limits that apply to defined contribution plans and are not counted against an employer’s deduction limit. (This change is effective for taxable years beginning after December31, 2001.)
Exclusion Allowance Repealed
The exclusion allowance applicable to 403(b) annuities is repealed. Accordingly, 403(b) annuities are subject to the same contribution limitation that is applicable to tax-qualified plans. (This change is effective for years beginning after December 31, 2001.)
Employee Elective Deferrals No Longer Taken into Account for Purposes of Calculating Deduction Limits
Employee elective deferral contributions (including "catch-up" contributions) will no longer be considered employer contributions for purposes of calculating the 25% of compensation deduction limit. (This change is effective for years beginning after December 31,2001.)
"Multiple Use" Test Repealed
The restriction on "multiple use" of the alternative limits for 401(k) plans with employer matching contributions is repealed. (This change is effective for years beginning after December 31, 2001.)
"Same Desk Rule" Repealed
The distribution restrictions applicable to 401(k) plans and 403(b) annuities are modified to provide that distributions may occur upon severance from employment rather than separation from service. The effect of this modification is that the "same desk rule" is eliminated. Under the "severance from employment" standard, participants in 401(k) plans and 403(b) annuities will not be prevented from receiving distributions in the event they continue on the same job for a different employer following a liquidation, merger, consolidation or other corporate transaction. In addition, the provisions for distribution from a 401(k) plan based upon a corporation’s disposition of its assets or a subsidiary are repealed. (This change is effective for distributions made after December 31, 2001, regardless of when the actual severance from employment occurred.)
Reduction of Time During Which Employee 401(k) Elective Deferrals Are Prohibited after Hardship Distributions
The IRS is directed to revise the safe harbor regulations to require only a six-month period of time during which an employee is prohibited from making elective contributions and after-tax contributions in order for the distribution to be deemed necessary to satisfy an immediate and heavy financial need. (This change is effective for years beginning after December31, 2001.)
Changes That Generally Affect Only Defined Benefit Plans
Maximum Annual Benefit Payment from Defined Benefit Plans Increased
The maximum annual benefit an individual can receive from a defined benefit plan will increase to $160,000. This dollar amount is indexed for inflation in $5,000 increments. In addition, the dollar limit is reduced for benefit commencement before age 62 and increased for benefit commencement after age 65.(This change is effective for years ending after December 31, 2001.)
Full Funding Limit Increased
The full funding limit will increase to 165% of current liability in 2002 and to 170% in 2003. The full funding limit is repealed beginning in 2004. (This change is effective for plan years beginning after December 31, 2001.)
Special Rules Governing Deductibility Expanded
The special rule allowing a deduction for amounts contributed of up to 100% of a plan’s unfunded current liability has been extended to all defined benefit pension plans, including multi-employer plans and plans with 100 or fewer participants. The special rule does not, however, apply to plans not covered by the PBGC termination insurance program. For plans with 100 or fewer participants during the plan year, the unfunded current liability does not include the liability attributable to benefit increases for highly compensated employees resulting from an amendment which was made or became effective, whichever is later, within the last two years. Finally, with respect to a defined benefit pension plan which terminates during a plan year, the maximum deductible amount for the plan year is the amount required to make the plan sufficient to pay benefit liabilities. (This change is effective for plan years beginning after December 31, 2001.)
Excise Tax Relief for Sound Pension Funding
In determining the amount of nondeductible contributions, an employer may elect not to take into account contributions to a defined benefit pension plan except to the extent that such contributions exceed the accrued liability full funding limit. The effect of the election is that contributions in excess of the current liability full funding limit are not subject to the excise tax on nondeductible contributions. (This change is effective for years beginning after December 31, 2001.)
Modifications of Timing of Plan Valuations
The annual valuation must be as of a date within the plan year to which the valuation refers or within one month prior to the beginning of such plan year. The valuation date, however, may be any date within the prior plan year if, as of such date, plan assets are not less than 125% of the plan’s current liability on that valuation date. (This change is effective for plan years beginning after December 31, 2001.)
Changes That Generally Affect Plans
That Are or Might Become Top Heavy Definition of "Key Employee" Simplified for Purposes of the Top Heavy Rules. The definition of "key employee" has been modified in several ways. First, the category for the top-10owner-key employees has been eliminated. Second, the determination of whether an officer is a "key employee" will be based on whether the officer had annual compensation greater than $130,000 for the preceding plan year (adjusted for inflation in $5,000 increments beginning in 2003). Finally, in determining "key employee" status, only the preceding plan year is considered (i.e., the four-year look-back period is eliminated). (This change is effective for years beginning after December 31,2001.)
Reduction in Time Period for Distributions Accounted for in Top Heavy Determination
In determining whether a plan is top heavy, distributions during the one-year period ending on the date the top heavy determination is being made will be taken into account. For in-service distributions, however, the time period is unchanged; distributions made within five years of the top-heavy determination date will be taken into account. (This change is effective for years beginning after December 31, 2001.)
Benefits Not Taken into Account If Employee Is Not Employed for Last Year Before Determination Date
In determining whether a plan is top heavy, a participant’s accrued benefit or account balance is not taken into account if the participant has not performed service for the employer during the one-year period ending on the date the top heavy determination is being made.(This change is effective for years beginning after December 31, 2001.)
Matching Contributions Satisfy Minimum Benefit Requirement for Non-key Employees
Employer matching contributions may be taken into account in determining whether the top heavy minimum benefit requirement has been satisfied for a defined contribution plan and still be treated as a matching contribution for purposes of the ACP test under section 401(m) of the Code. (This change is effective for years beginning after December 31, 2001.)
Safe Harbor 401(k) Plans Not Top Heavy
A 401(k) plan that satisfies the designed-based safe harbor for such plans and matching contributions that satisfy the safe harbor rule for such contributions is not a top-heavy plan. (This change is effective for years beginning after December31, 2001.)
Frozen Top Heavy Defined Benefit Plans Exempt from Minimum Benefit Requirements
In determining the minimum benefit required under a defined benefit plan, any year in which the plan is frozen is not considered a year of service for purposes of determining an employee’s years of service. (This change is effective for years beginning after December 31, 2001.)
That Generally Affect Only Small Businesses
Small Business Tax Credit for New Retirement Plan Startup Costs
Small businesses which adopt a new qualified defined benefit or defined contribution plan (including a 401(k) plan, a SIMPLE plan, or a simplified employee pension) will be eligible for a nonrefundable income tax credit of 50% of the administrative and retirement-education expenses incurred in establishing the new plans, up to $500 per year for each of the first three years of the plan. To qualify, the small business must have no more than 100 employees who received at least $5,000 in compensation from the employer for the preceding year and must cover at least one non-highly compensated employee. The tax credit is not available to an employer that has established or maintained a plan (or a member of a controlled group including the employer which maintained a plan) for substantially the same employees during the three-tax-year period immediately preceding the first tax year in which the new plan is established. (This change is effective with respect to costs paid or incurred in taxable years beginning after December 31, 2001, with respect to qualified employer plans established after such date.)
Elimination of IRS User Fees for Certain Determination Letter Requests
The IRS user fees of $125 to $1,250 for a determination letter request on the tax-qualified status of a retirement plan will not be assessed on small businesses if the request is made before the last day of the fifth plan year of the plan.
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To qualify, the small business must have no more than 100 employees who received at least $5,000 in compensation from the employer for the preceding year and must cover at least one non-highly compensated employee. (This change is effective for determination letter requests made after December 31, 2001.) |
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Contact for more information: Lisa M. Burman, John W. Dubbs, III, James D. Harbert, Anthony J. Jacob, Marcia L. Mueller
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