In June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) which provides a $1.35 trillion tax cut over the next several years, including $49.6 billion which was drafted to increase savings to retirement plans and IRA’s. All of these provisions will apply to plan years beginning after December 31, 2001. The Treasury plans to issue guidance later this year to clarify the actual mechanics of the tax act. In order to comply with the Congressional Budget Act of 1974, Act Section 901 of EGTRRA provides that all provisions and amendments made by the 2001 Act will not apply to taxable or plan years beginning after 2010. The Internal Revenue Code (IRC) and ERISA will thereafter be applied and administered as if these provisions and amendments had not been enacted. The following is a summary of the retirement plan provisions.

The compensation limit is increased from $170,000 to $200,000 beginning in 2002 and is indexed in $5,000 increments for inflation thereafter in applying employer deduction rules, nondiscrimination testing and determining employer contributions. Increasing the compensation limit will reduce the 401(k) deferral percentages of certain highly compensated employees which should help employers pass nondiscrimination testing.

Employer deduction limits for contributions to profit sharing plans are increased from 15 percent of compensation to 25 percent. Employee 401(k) and Section 125 cafeteria plan contributions are deducted separately and are not included in applying any such limitation to any other contributions. Participant compensation used to determine the 25 percent limit includes 401(k) and Section 125 deferrals. This provision should eliminate the need for Money Purchase Plans and hopefully increase the amount Americans save for retirement. Recent studies indicate that Baby Boomers have less than 40 percent of the amount necessary to retire without reducing their current standard of living.

Under EGTRRA, a plan is top heavy if 60 percent or more of the current plan assets and the previous year’s distribution or accrued benefits belong to key employees. However, distributions made for a reason other than separation from service, death or disability is included for five years. A key employee is defined as an individual who during the prior year was a 5 percent owner, a 1 percent owner earning in excess of $150,000 or an officer earning in excess of $130,000. Both dollar amounts are subject to cost of living increases in $5,000 increments.

Matching contributions will now count toward the top-heavy minimum contribution and also be included in the ACP test. Safe Harbor 401(k) Plans matching contributions will meet the top-heavy requirements. Frozen defined benefit plans are exempt from minimum benefit requirements and can disregard employees’ years of service after the plan is frozen.

The Multiple Use Test is repealed, which previously prevented the use of the alternative limit (either "times 2" or "plus 2" rule) in satisfying both the ADP & ACP tests.

Annual addition percentage limitation is increased from the lesser of $30,000 or 25 percent of compensation to the lesser of $40,000 or 100 percent of compensation.

401(k)/403(b) Plans’ employee contribution limits are increased from $10,500 to $15,000 from 2002 through 2006 and indexed for inflation after 2006. Simple Plans employee contribution limits are increased from $6,500 to $10,000 from 2002 through 2005 and indexed for inflation after 2006. IRAs/Roth IRAs individual contribution limits are increased from $2,000 to $5,000 from 2002 through 2008 and indexed for inflation after 2008.

2001                     $10,500                             $ 6,500                          $2,000
2002                       11,000                                7,000                            3,000
2003                       12,000                                8,000                            3,000
2004                       13,000                                9,000                            3,000
2005                       14,000                              10,000                            4,000
2006                       15,000                             (Indexed)                         4,000
2007                      (Indexed)                                                                  4,000
2008                                                                                                       5,000
2009                                                                                                     (Indexed)
 

Plans may allow individuals who are at least age 50 before the end of the plan year to make catch up contributions to 401(k)/403(b) and Simple Plans. Catch up contributions do not count toward maximum elective deferral limits under 401(k)/403(b) plans. Also, catch up contributions are not included in nondiscrimination testing (ADP/ACP). According to the Conference Committee Reports, employers are allowed to contribute matching contributions for catch up contributions, subject to nondiscrimination testing. Note that many questions remain unanswered as to determining which contributions are deemed catch up contributions.

 Year                401(k)/403(b)Plans              Simple Plans
2002                       $1,000                             $   500
2003                         2,000                               1,000
2004                         3,000                               1,500
2005                         4,000                               2,000
2006 and thereafter   5,000                               2,500
 

After December, 31, 2001, sub-chapter S shareholders, partners in partnerships, and sole proprietors of unincorporated businesses can take out loans without the loan being treated as a prohibited transaction.

Employees who elect hardship withdrawals after December 31, 2001 will only have to wait six months (currently twelve months) to continue 401(k) deferrals. All hardship withdrawals are no longer eligible rollover distributions.

Under the new law, employer matching contributions made for plan years beginning after December 31, 2001 must vest according to one of the following two schedules:

• 3 year cliff, 100 percent vesting after three years; (Y1 - 0%; Y2 - 0%; Y3 - 100%)

• 6 year-graded schedule, 20% percent after two years of service and 20% each year thereafter, with 100 percent after six years of service; (Y1 - 0%, Y2 - 20%, Y3- 40%, Y4- 60%, Y5- 80%, Y6 - 100%).

Special rules apply to union plans and require that these rules do not take effect until the earlier of: (1) the later of the last bargaining agreement termination date or January 1, 2002, or (2) January 1, 2006.

The maximum annual benefit payable at retirement for defined benefit plans is increased from $140,000 to $160,000. The dollar limit is reduced if benefits begin before age 62 and increased if benefits begin after age 65, instead of the social security retirement age as under prior law.

Plan sponsors of plans subject to minimum funding standards of ERISA such as defined benefit and money purchase plans are required by the new law to provide participants advance written notice concerning any plan amendments which significantly reduce future benefits. The new notice must be provided to each participant in the plan whose rate of future benefit accruals under the plan is significantly reduced. The new law imposes an excise tax for failure to meet the notice requirements.

EGTRRA makes a direct rollover to an IRA the default option when a plan forces a payout of more than $1,000 to a participant who has an account balance of less than $5,000, if the participant does not make an election to receive either a lump sum distribution or rollover their account balance. This rule will not take effect until the Treasury issues regulations.

Effective 2002, participants in qualified plans, 403(b) and 457 plans may rollover their plan assets into any of these other retirement plans or IRAs. Participants can also rollover their IRAs into 403(b) and 457 plans. The revised rollover rules allow employees to roll over Simple IRA and IRA accounts into defined contribution plans such as profit sharing and 401(k) plans.

15. IRS determination user fees

Small employers are exempt from paying user fees to obtain a determination letter for a new plan, if the letter is requested within the first five years of the plan (or at the end of any remedial amendment period, if later). Small employers are defined as "generally employing less than 100 employees with compensation of $5,000 or more in the prior year." This should encourage small employers to adopt a retirement plan since it lowers the initial fee.

This tax act repealed the same desk rule which prohibited a 401(k), 403(b) and 457 plans from distributing an employee’s balance when the employee continued in the same job with a successor employer after a consolidation, liquidation, merger or other transaction. This should increase the portability of retirement benefits.

Small employers, defined as having no more than 100 employees, will receive a tax credit for a portion of the costs associated with setting up a new retirement plan (defined benefit, 401(k) profit sharing and Simple plans) for plans beginning after December 31, 2001. The tax credit equals 50 percent of the start-up costs incurred, with a maximum of a $500 credit per year. The credit can be claimed for three years beginning with the year the plan is set-up. The costs incurred cannot be claimed as a tax credit and deducted as a business expense.

Low and middle income taxpayers are eligible for a non-refundable credit for contributions to 401(k), 403(b) & 457 plans. The maximum credit is 50 percent of the first $2,000 in contributions and is phased out at adjusted gross income of $50,000 for joint filers, $37,500 for head of household filers, and $35,000 for single and married filing separately filers. Currently, the credit applies only to the years 2002 through 2006.

Effective for tax years beginning after 2005, 401(k) & 403(b) plans can offer participants the option to designate a portion of their contributions to the plan as after-tax Roth contributions. Roth contributions are after-tax contributions which grow tax free and are not subject to taxation upon distribution. Applicable employee contribution limits remain the same.

As the Treasury Department issues guidance on these provisions, Administrative Retirement Services, Inc. will provide plan design and implementation suggestions. If you have any questions, do not hesitate to contact us.

The IRS issued Announcement 2001-77 in July 2001which extends the GUST Remedial Amendment Period to December 31, 2002, due to the Economic Growth & Tax Relief Reconciliation Act of 2001. Plan sponsors (Employers) have until the later of December 31, 2002 or 12 months after their plan document sponsor (Administrator) receives IRS approval, to adopt and submit their plan to IRS for approval. Employers must complete a Certification to Extend the Remedial Amendment Period prior to December 31, 2001, unless the employer restates their plan using the same administrator that sponsored their current document.

Administrative Retirement Services, Inc. (ARS) will sponsor a plan document and has submitted its documents to IRS for approval and expects to receive approval before year-end. In September ARS will be mailing a Certification to Extend the Remedial Amendment Period and a document questionnaire to begin the restatement process.

Restating your retirement plan is an excellent time to review your plan provisions and make changes to improve your retirement program. Several changes we recommend considering can be found later in this article.

• Add a Cross Tested Contribution Formula. These plans are the hottest planning concepts in qualified plans today. They have an individually designed allocation formula which segregates the employees into two or more employer defined classes, with each class entitled to a separate contribution percent. These plans must demonstrate nondiscrimination by showing that the benefits, as a percentage of current compensation, are not discriminatory. Ask us for a demonstration on how this can benefit your company.

• Add a Safe Harbor or SIMPLE formula. Both SIMPLE and Safe Harbor 401(k) plans allow employers to avoid nondiscrimination and top-heavy testing but require the employer to contribute either a matching or non-elective amount which is 100 percent vested. A timely notice describing employee rights and obligations under the plan must be provided.

• Review plan eligibility. Did you know that you can allow employees to immediately contribute to the 401(k) and wait a year to be eligible for employer contributions (profit sharing and match)?

• Review plan compensation. Does your plan document correctly state what compensation is included for plan purposes? Is your compensation as of date of plan participation or first day of the plan year? Does it include 401(k) contributions? Plan Sponsors have several options and should explore them during this restatement period.

• Review plan loans. Does your document allow loans? Does it limit the number of loans to one or two? Does it charge a proper rate of interest such as prime or prime plus one? After December, 31, 2001, sub chapter S shareholders, partners in partnerships, and sole proprietors of unincorporated businesses can take out loans without the loan being treated as a prohibited transaction.

This is just a sample of the items we will be addressing when we restate plans over the next year. At Administrative Retirement Services, Inc. we believe the preparation of your plan document is the most important aspect of your retirement plan. To discuss your plan provisions and the options available contact Administrative Retirement Services, Inc.

© Administrative Retirement Services, Inc.  2000
Published by Administrative Retirement Services, Inc., E-mail address:  arsinc@prodigy.net.  Copyright 2001 by Administrative Retirement Services, Inc. Reproduction in whole or in part is prohibited except by written permission. All rights are reserved.  Information has been obtained by Administrative Retirement Services, Inc. from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, Administrative Retirement Services, Inc. or others, Administrative Retirement Services, Inc. does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or the result obtained from the use of such information.  Readers should seek specific advice before acting with regard to the subjects mentioned here.

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