United States: As GUST Amendment Deadline Looms, EGTRRA Changes The Law Again

Originally appeared in Benefits & Compensation Bulletin Volume IX, Number 3

Four federal laws enacted in the past decade, collectively known as "GUST," require a broad range of changes to tax-qualified retirement plans. The Internal Revenue Service ("IRS") has pushed back the GUST amendment deadline once again; now, plans with plan years ending in December 2001, January 2002, and February 2002 must be amended to comply with GUST (and must also be submitted to the IRS for approval) by February 28, 2002. All other plans must be amended to comply with GUST (and submitted to the IRS) by the end of the plan year beginning in 2001.

For the moment, plan sponsors will need to focus on finalizing their GUST amendments and preparing IRS filings. Failure to timely amend a plan for GUST could jeopardize the plan’s qualified status. But plan sponsors and administrators also need to be aware of the important changes affecting retirement plans that were signed into law just a few months ago.

The recent tax relief legislation - the Economic Growth and Tax Relief Reconciliation Act of 2001, or "EGTRRA" - has not only provided federal income tax relief for individuals, but has also made an array of changes in the law relating to retirement plans. While plan amendments are not required at this time, many of the new rules go into effect in 2002. A summary of the principal EGTRRA changes is given below.

In the past, legislation affecting retirement plans has tended to limit the benefits plan participants may accrue. EGTRRA, however, offers plan participants the chance to accrue greater benefits and also liberalizes tax deduction rules for plan sponsors, as the following changes show:

Compensation. Beginning in 2002, the maximum amount of compensation that can be taken into account under qualified retirement plans and 403(b) plans will increase to $200,000. The $200,000 limit will be indexed for inflation in $5,000 increments.

A separate article (see page 4) explains how this change will affect defined benefit pension plans.

Elective Deferrals. The current $10,500 limit on elective deferrals under 401(k) plans will increase to $11,000 in 2002. In the following years, the limit will increase in $1,000 increments until it hits $15,000 in 2006. After 2006, the $15,000 limit will be indexed for inflation.

Contribution Limit. Both of the annual contribution limits under defined contribution plans have been changed. The maximum dollar amount that can be contributed for a participant in an individual account plan will be raised to $40,000 in 2002 and will then be indexed for inflation in $1,000 increments. The percentage-of-salary limit will be increased to 100% of salary.

Benefit Limit. Effective for years ending after December 31, 2001, the dollar limit on a participant’s annual pension under a defined benefit plan will increase to $160,000. An actuarial reduction in this dollar limit will be required only if the participant’s pension commences before he/she reaches age 62.

Multiemployer Plan Limit. For multiemployer plans, the "three year high" 100%-of-compensation limit on benefits is eliminated. In addition, an employer contributing to a multiemployer plan will not have to aggregate any plan it alone sponsors with the multiemployer plan for purposes of applying the 100%-of-compensation limit to the "single employer" plan.

Employer Deduction Limit. An employer’s tax deduction for contributions to a profit sharing or stock bonus plan has been increased to 25% of the compensation of the employees covered by the plan for the year.

Full Funding Limit. For 2001, an employer maintaining a defined benefit plan may not deduct contributions to the plan if they exceed (a) 160% of the plan’s current liability or (b) a limit based on a "reasonable projection" of benefits. This "full funding limit" will increase after 2001: it will go up to 165% of the plan’s current liability in 2002 and 170% in 2003, and will be eliminated entirely for 2004 and later years.

Beginning in 2002, employee after-tax contributions may be rolled over from 401(k) plans and other tax-qualified retirement plans to other plans and IRAs. Currently, rollovers of employee after-tax contributions are not permitted.

In addition, beginning in 2002, amounts that an individual has contributed directly to an IRA may be rolled over to another IRA or to an employer’s retirement plan. Such rollovers are generally not permitted now.

Beginning in 2002, amounts from 401(a) plans, 403(b) plans, and 457(b) plans may generally be rolled over to other 401(a), 403(b), or 457(b) plans, without the requirement to "match" retirement plans by Internal Revenue Code section. Amounts from a 457(b) plan may also be rolled over to an IRA.

Beginning in 2002, employer matching contributions (but not other employer contributions) must vest either after three years of service or under a "2/20" graded vesting schedule. These accelerated vesting schedules formerly applied only to top-heavy plans.

Currently, an employer may take a tax deduction for dividends paid on the employer stock in an ESOP only if the dividends are paid to plan participants in cash. Beginning in 2002, a deduction will be allowed if ESOP participants have the option to take the dividends in cash or leave them in the ESOP for reinvestment.

Currently, a plan participant who does not contribute the maximum permissible amount to his/her salary reduction plan in a given year may not make "catch-up" contributions in later years. Beginning in 2002, plan participants age 50 and older will be allowed to make "catch-up" contributions to salary reduction

plans, as follows:

Beginning in 2007, these limits on catch-up contributions will be indexed for inflation in $500 increments. Catch-up contributions will not be subject to nondiscrimination rules or other contribution limits.

The limit on IRA contributions will go up to $3,000 in 2002 through 2004; will be $4,000 from 2005 through 2007; and will be $5,000 in 2008. It will be indexed for inflation in $500 increments after 2008. Individuals age 50 and over will be permitted to make catch-up contributions to IRAs of $500 in 2002 through 2005 and $1,000 in 2006 and later years.

Under ERISA section 204(h), an employer may not reduce the rate of future benefit accrual under a defined benefit or money purchase pension plan unless participants and alternate payees are notified first. The rules for giving "204(h) notices" are liberalized for plan amendments that take effect after June 7, 2001, the date on which President Bush signed EGTRRA into law.

EGTRRA makes a number of other changes affecting retirement plans; these generally simplify current law. For example:

• The "multiple use" test for 401(k) plans is repealed.
• The maximum amount that can be contributed by elective deferral to 457(b) plans will mirror the limit for 401(k) plans.
• The maximum exclusion allowance for 403(b) plans is eliminated.
• The "same desk" rule is eliminated. This troublesome IRS rule has long held that an employee has not actually "separated from service" - and thus may not receive a distribution from a 401(k), 403(b), or 457 plan - if he/she continues to perform the same job for a successor employer.
• The top-heavy rules are changed by simplifying the definition of "key employee," shortening the look-back period, and exempting 401(k) and 401(m) "safe harbor" plans from the top-heavy rules.

It is important to note that all the provisions discussed above will expire after December 31, 2010. For plans with plan years other than a calendar year, the applicable provisions will expire with the first plan year commencing after December 31, 2010.