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| New Tax Legislation Affects Retirement Plans On June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (the 'Act'). In addition to its more notable provisions (which reduce income tax rates, increase IRA limits and eliminate the estate tax), the Act makes numerous changes to the nation's pension and benefit laws. Although some of these changes are phased in over time, certain changes have an effective date of January 1, 2002 or earlier. This means that employers of all sizes should begin considering the Act's advantages and requirements, some of which will require plan amendments. Employers that sponsor retirement plans can expect a steady stream of guidance and regulations relating to the Act over the next few years from the Internal Revenue Service and other governmental agencies. The following briefly identifies the major pension and employee benefit provisions that are applicable for most employers and which generally have an effective date of January 1, 2002: Retirement Plan Limits: A number of dollar limitations have been significantly increased for 2002 and indexed for future years. For 2002, the $10,500 limit on 401(k) contributions will be raised to $11,000 and thereafter increased by $1,000/year until $15,000 in 2006, the overall annual additions limit under defined contribution plans will be raised from $35,000 to $40,000, the annual benefit payable under defined benefit plans will be raised from $140,000 to $160,000 and the compensation dollar limit under IRC §401(a)(17) will be raised from $170,000 to $200,000. In addition, the new law significantly increases contribution limits for lower-income participants by modifying the section 415 annual addition limitation to 100% (rather than 25%) of compensation. We would expect most employers to find these limits beneficial, other than employers who desire to keep benefits at current levels and those which cross-test their plans. Deduction limitations: Deduction limits for profit sharing plans have been significantly increased from 15% to 25% of aggregated participant compensation. The increase should eliminate the need for money purchase plans in most situations. Existing money purchase plan can be converted into profit sharing plans. Dividends on employer securities: Dividends paid on employer stock owned by an ESOP will be deductible if participants are given an opportunity to receive the dividends in cash or having them retained by the ESOP. It may be possible for certain 401(k) plans that are substantially invested in employer stock (where dividends are paid on such employer securities) to qualify as an ESOP to permit the plan sponsor to take a deduction for dividends paid on employer stock held by the plan. Catch-up contributions for individuals age 50 and older: Plans may now allow an individual age 50 and older to make 'catch-up' pre-tax contributions under a 401(k) plan. The maximum catch-up contribution is $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006. The catch-up contribution does not count against the plan's normal contribution limits. A plan amendment is necessary and is a cost-free way for employers to offer additional benefits to older employees. Faster vesting for matching contributions: The new law requires 3-year cliff vesting, under which contributions become fully vested after 3 years, or 6-year graded vesting, under which contributions vest gradually over 6 years. A plan that provides a less generous vesting schedule for matching contributions must be amended. Involuntary distributions: If a plan makes an involuntary distribution of more than $1,000, and the employee does not affirmatively elect to receive cash or to make a direct rollover, the default method of payment must be a direct rollover to an IRA. This rule does not take effect until the Secretary of Labor issues regulations. In addition, employers can disregard the amount of any rollovers (and earning thereon) in determining whether the present value of a participant's benefit is below the automatic cash-out limit of $5,000. Changes to top-heavy rules: The new law makes some changes to the top-heavy rules, including modifying the definition of who qualifies as a key employee. Under the new rules, many plans will no longer need to provide minimum annual contributions to non-key employers. Multiple use test repealed in 2002: The complex multiple use test for defined contribution plans that offer matching contributions is repealed for plan years beginning in 2002 and later. This change should be beneficial to employers that sponsor 401(k) plans that have difficulty passing the existing nondiscrimination rules. Hardship withdrawals: Treasury regulations currently require a 401(k) plan to suspend a participant's right to make elective deferrals or after-tax employee contributions for a period of one year following a hardship withdrawal. The mandatory suspension period has been reduced to six months for hardship withdrawals that occur after December 31, 2001. Additionally, the new law provides that all hardship withdrawals are ineligible for rollover. Portability of benefits among all employer-sponsored retirement plans: Effective for distributions made after December 31, 2001, the Act makes it easier for amounts (including after-tax amounts) to be rolled over among and between all types of qualified plans retirement plans and IRAs. Uniform loan rules for all business owners: The new law eliminates the current prohibition on making plan loans to certain participants who are owners of a sole proprietorship or partnership, or S corporation shareholders. Beyond the provisions identified above, which primarily relate to defined contribution plans, the Act also includes significant changes applicable to defined benefit and other employee benefit plans. Additionally, the Act may have a significant effect on employer-sponsored nonqualified plans (e.g., the need for these types of plans may be reduced due to the increases in the qualified plan benefit limitations discussed above). For additional information, please contact a member of the Pension & Benefits Group at Davis & Gilbert LLP. We would be happy to discuss with you in detail the provisions of the new Act or any other employee benefits matter. © 2002 Davis & Gilbert LLP |
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