United States: Qualified Retirement Plans: February 2005 Developments

Automatic rollover provisions apply to mandatory distributions made on or after March 28, 2005. Involuntary cash outs of more than $1,000 (but less than $5,000) are required to be automatically rolled over to an IRA on and after March 28, 2005, unless the participant elects otherwise. Many employers intend to comply with this rule by reducing the mandatory cash out amount to $1,000, or by completely eliminating mandatory distribution provisions. The IRS has said that plans must operationally comply with these rules beginning March 28, 2005, (except for certain government and church plans), and plan amendments must be adopted by the end of the first plan year ending on or after March 28, 2005.

IRS has released proposed guidance on Roth IRA-style contributions to 401(k) plans. Under new Internal Revenue Code Section 402A, effective for plan years beginning on or after January 1, 2006, a 401(k) plan may permit participants to designate that some or all of their elective contributions should be treated as being made on an after tax basis, similar to contributions made to Roth IRAs. The restrictions that limit Roth IRA contributions to individuals with compensation below certain levels ($110,000 for single individuals and $160,000 for married individuals) do not apply to Roth 401(k) contributions. This means that higher income employees are likely to be very curious about this new alternative, since they have not previously been eligible to make Roth IRA contributions. The regular 401(k) contribution limits apply, and Roth 401(k) contributions are in addition to the maximum amounts that may be contributed to Roth IRAs, so even lower compensated participants already familiar with Roth-style retirement savings may be intrigued.

The President’s FY 2006 budget message once again pushes for simpler long-term savings programs. Current law IRAs would be replaced with two new savings accounts, the Lifetime Savings Account (LSA) and the Retirement Savings Account (RSA). Regardless of age or income, individuals could make annual nondeductible contributions of $5,000 to an LSA. Contributions up to $5,000 (or earnings, if less) could be made to an RSA. All distributions from an LSA at any time would be nontaxable. Distributions from an RSA would be nontaxable after age 58 or in the event of death or disability. Existing Roth IRAs would be renamed RSAs and all traditional IRAs could be converted to RSAs without regard to income limits. Existing 401(k) plans, SIMPLE 401(k) plans, 403(b) plans and 457 plans would be combined into a single type of account called an Employee Retirement Savings Account (ERSA) that would be available to all employers. Under one safe harbor option, providing a 50% match on employee contributions up to 6% of pay would satisfy all nondiscrimination requirements.

Just when the rules might be getting simpler, the IRS promises an invigorated enforcement program. The IRS Tax Exempt and Government Entities ("TE/GE") Commissioner spoke recently on the subject of more vigorous enforcement of the rules governing retirement plans. He said that the IRS is finding an increasing number of abusive transactions in the TE/GE community and that the IRS has been inactive in enforcement of the rules in this area for too long. More emphasis on enforcement was promised.

The Centers for Medicare and Medicaid Services (CMS) issued a study indicating that the public sector will account for half of the nation’s health care spending by 2014. Aiding in the trend is the new Medicare prescription drug benefit which will shift substantial spending on drugs from the private to the public sector. Public sector spending on health care was 45.7% of total health care spending in 2004. Total health care spending is expected to be $1.8 trillion in 2004. By 2014, health care spending is projected to be 18.7% of gross domestic product, up from 15.4% in 2004.

It is all hypothetical, of course, but Congress can raise $164 billion over 10 years by requiring FICA taxes to be paid on salary reduction amounts contributed under cafeteria (Code Section 125) plans. FICA tax is already collected on elective deferrals to 401(k) plans. In these days of large federal deficits all options to increase revenue without increasing tax rates are under scrutiny.

New IRS Publication 969, "Health Savings Accounts and Other Tax-Favored Health Plans," has been released and is available on the IRS’ website (www.IRS.gov). This publication previously covered only medical savings accounts (MSAs), but now it includes information on health savings accounts (HSAs), flexible spending accounts (FSAs), and health reimbursement accounts (HRAs).

The Department of Labor has posted Spanish language versions of the Model COBRA General Notice and Model COBRA Continuation Coverage Election Notice on its website. For a copy of the Model Notice go to www.dol.gov./ebsa/ModelGeneralNoticeSP.doc. For a copy of the Model Election Notice go to www.dol.gov/ebsa/ModelElectionNoticeSP.doc.

Recent cases have involved payments in consideration of a noncompete provision, paid on the last day at work; payment of a retention bonus; and the proceeds of the exercise of stock options. There are no right or wrong answers. Any compensation paid to an employee may be considered as compensation for pension and SERP calculations. But, it is preferable to have "compensation" definitions that address these increasingly common occurrences directly, rather than have to deal with ambiguity after the fact in expensive litigation. Karras v. First Colony Life Insurance Co. Pension Plan, W. D. VA, No. 6:03CV0005 (2/15/2005); Wolberg v. AT&T Broadband Pension Plan, 2005 WL 23683 (10 Cir. CO) January 6, 2005; Scipio v. United Bankshares, Inc., 2004 WL 2980756 (4 Cir. W. VA) December 22, 2004.

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