Retirement Plans and the
2001 Tax Act
Tax legislation passed in
June of 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"),
imposes on employers the obligation, once again, to amend their qualified
retirement plans. EGTRRA requires
employers to implement plan changes that are generally effective for the 2002
plan year.
The good news is that EGTRRA
generally increases benefit limits and presents some attractive design options
for defined contribution and 401(k) plans.
The EGTRRA highlights
include:
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Increases in the dollar limit for both defined benefit plans (the annual
limit increases from $140,000 per participant to $160,000) and defined
contribution plans (the annual dollar limit increases from $35,000 per
participant to $40,000). These
limits, as under current law, are indexed to reflect increases in the cost
of living. The per participant defined contribution percentage limit
also increases from 25 percent of annual compensation to 100 percent.
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Increases in the
dollar limit for both defined benefit plans (the annual limit increases
from $140,000 per participant to $160,000) and defined contribution plans
(the annual dollar limit increases from $35,000 per participant to
$40,000). These limits, as
under current law, are indexed to reflect increases in the cost of living. The per participant defined contribution percentage limit
also increases from 25 percent of annual compensation to 100 percent.
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The limit on annual
compensation that can be taken into account for benefit computation
purposes is increased to $200,000 (indexed) for the 2002 plan year
from the current $170,000. The
deduction limit for contributions to profit sharing and stock bonus
plans increases from 15 percent to 25 percent of aggregated compensation.
This means many employers will be able to maintain a higher level
of contributions through a single profit sharing plan without the need to
maintain a separate money purchase pension plan.
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401(k) annual per
participant contribution limits increase from the current $10,500 to
$11,000 in 2002 with annual $1,000 increases thereafter up to $15,000
(indexed) in 2006. More
important, 401(k) contributions are exempted from the revised defined
contribution plan deduction limits. This
means that participants electing to make the maximum permitted 401(k)
contributions will not affect an employer’s ability to deduct both the
401(k) contributions and any profit sharing contributions it chooses to
make. For participants age 50
and older, an extra "catch-up" elective contribution of $1,000 is
permitted in 2002 and with an additional $1,000 provided in each
subsequent year until the $5,000 maximum applies in 2006.
Faster vesting of employer matching contributions also is required.
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Annual contribution
limits for both traditional and Roth IRA’s increase to $3,000 for the
next three years, then $4,000 annually for the following three years and
to $5,000 starting in 2008. Individuals
age 50 and over can contribute an additional $500 over the revised limits
each year for the next five years and an extra $1,000 starting in 2006.
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Rollover rights are
expanded so that employees can make benefit transfers between different
types of plans (qualified retirement plans, 403(b) plans and 457(b) plans)
as well as IRAs.
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Mandatory cashouts
apply to participants who have qualified retirement plans benefits valued
at $5,000 or less (prior legislation increased the previous cashout limit
from $3,500 to $5,000). EGTRRA
allows plans to exclude rollover contributions and their earnings in
calculating the value of a participant’s benefits for this purpose.
Employers may want to make this change effective as of the first
day of the 2002 plan year. For
mandatory cashouts greater than $1,000, retirement plans are permitted to
provide a default provision allowing the direct transfer of benefit
payouts to a participant’s IRA even if such a transfer is not
affirmatively elected by the participant.
Unlike prior benefits
legislation, EGTRRA requires "good-faith" plan amendments effective by no
later that the end of the 2002 plan year and in some cases before the end of the
2001 plan year. Final EGTRRA
amendments can then be adopted by the end of the 2005 plan year. Operation of retirement plans in compliance with the new law
with ratifying plan amendments adopted at a later time will not be accepted as
in the past.
The IRS has assisted with
the preparation of EGTRRA "good-faith" plan amendments by issuing sample
amendments. However, these
amendments will not be reviewed by the IRS in connection with any determination
application filed for "GUST" plan amendments.
Note, however, that prototype and master plans that adopt EGTRRA
amendments will be treated as individually designed plans.
Consequently, employers who have adopted master and prototype plans need
to be careful about how they deal with EGTRRA amendments.
As to employers maintaining
retirement plans that are not master or prototype plans, IRS sample amendments
increasing plan contribution limits should not be controversial and most
employers will want to adopt them. Employers
who want to implement plan design changes involving benefit reductions (for
example, terminating money purchase pension plans maintained for the primary
purposes of permitting the maximum annual defined benefit contribution) or
optional catch-up contributions effective as of January 1, 2002 will need to
adopt appropriate amendments before the end of 2001.
In addition to the amendment
requirements described above, employers must adopt and file with the IRS by the
end of the 2001 plan year (December 31, 2001 for calendar year plans) the "GUST" amendments reflecting statutory changes in the tax law dating back to
1994. The principal GUST operating
changes for most plans will be adoption of optional distribution rules for
participants who remain active employees after age 70 ½ and the increase of the
limit for involuntary cashout distributions from $3,500 to $5,000.
We recommend making certain
additional changes along with the GUST amendments, including adoption of
language incorporating the liberalized minimum distribution rules promulgated by
the IRS in January, 2001. As to the
EGTRRA changes, feel free to contact us if you have any questions about EGTRRA
and especially if you want to consider making any EGTRRA plan changes that
require action before the end of the current plan year.
As with other changes to
qualified retirement plans, EGTRRA and GUST plan amendments will need to be
described in a "summary of material modification" or a revised summary plan
description for distribution to participants.
Although the preparation of these documents in many cases will not be
required at this time, certain changes (including any termination of a money
purchase pension plan) require additional and more timely participant
notification.
The above, necessarily, is a
summary of certain EGTRRA provisions relating to qualified retirement plans.
EGTRRA contains provisions outside the retirement area that may present
other tax planning opportunities. For
example, EGTRRA revises the rules relating to personally funded college savings
plans (Section 529 Plans) to exempt plan earnings entirely from federal income
taxes if those earnings are used to pay qualified educational expenses at
colleges and universities. We can
help you with these and other EGTRRA provisions that affect you and your
business.
Andrew S. Williams
Aronberg Goldgehn Davis & Garmisa
One IBM Plaza, Suite 3000
Chicago, Illinois 60611
312/755-3145
awilliams@agdglaw.com
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