Vol. 13, No. 5, Pg. 12. Highlights of qualified retirement plan changes under EGTRRA.


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Vol. 13, No. 5, Pg. 12.

Highlights of qualified retirement plan changes under EGTRRA

12Highlights of qualified retirement plan changes under EGTRRA By John R. Thomas The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) represents a significant shift in government policy by substantially enhancing retirement plan benefits. The following briefly discusses some of the major changes EGTRRA makes in the qualified retirement plan area. EGTRRA's provisions are generally effective for plan years beginning in 2002. It is noteworthy that the new law will sunset after 2010 unless Congress acts to prevent the repeal. Overall, EGTRRA is an attempt by Congress and the Bush administration to encourage employers to establish retirement plans for employees and employees to participate in the plans.

14 Increased elective deferrals

The primary advantage of a 401(k) plan is the participant's ability to reduce his compensation and contribute the deferred amount to the plan before income taxes. The deferred amount is generally referred to as elective deferrals. The participant's elective deferrals and any earnings thereon are tax-deferred until later paid to the participant or his beneficiary, usually upon termination of employment or death.

Prior to EGTRRA, the maximum compensation a participant could contribute to the plan through elective deferrals was $10,500. Elective deferral amounts could increase because of cost of living (COLA) adjustments, but only in increments of $500. Since inflation has been low for some time, the COLA adjustments have been very slow in coming. EGTRRA significantly increases the amount a participant can contribute over a five-year period as follows:

Elective Deferral Year

Amount $11,000 2002 $12,000 2003 $13,000 2004 $14,000 2005 $15,000 2006 After 2006, the $15,000 limit is indexed for COLA and will increase in $500 increments.

Catch-up deferrals

One of the most unique provisions of EGTRRA permits older employees to make "catchup" elective deferrals to a 401(k) plan beginning in 2002. As discussed above, the normal elective deferral limit is $11,000 for 2002. However, beginning in 2002 the plan can allow those employees who become age 50 or older at any time during the plan year to defer additional amounts of compensation. This catchup deferral amount is limited to the lesser of the participant's compensation reduced by his normal elective deferrals or the following dollar amounts:

Additional AmountYear $1,000 2002 $2,000 2003 $3,000 2004 $4,000 2005 $5,000 2006 and thereafterFor example, in 2002 a participant has $40,000 in compensation and his employer's 401(k) plan permits both normal elective deferrals (up to $11,000) and catchup elective deferrals ($1,000 in 2002). The participant turns 50 on December 31, 2002. Assuming all other required 401(k) limitations in the plan are met, participant can defer $12,000 ($11,000 plus $1,000 catchup) in 2002 and $20,000 ($15,000 plus $5,000 catchup) in 2006.

Catchup elective deferrals are not subject to the annual additions limitations of IRC § 415 (discussed below). Further, they are not subject to the normal plan non-discrimination rules. For example, if the participant (who is age 50 or older) is a highly compensated employee and is limited to a $3,000 normal elective deferral because of the non-discrimination elective deferral test, the participant will still be able to defer an additional $1,000 as a catchup elective deferral for a total elective deferral of $4,000.

While the plan can permit the employer to match the participant's catchup elective deferral, the matching contribution must satisfy the IRC § 401(m) test for non-discrimination. Since it is likely catchup elective deferrals will be made to a large extent by highly compensated employees, many plans will probably elect not to match on the catchup elective deferral to avoid potential violation of the IRC § 401(m) non-discrimination test.

It is important to note that the law does not require a 401(k) plan to permit catchup elective deferrals. Consequently, the employer will need to amend the plan to allow participants to make such deferrals.

Increased annual addition limitations for defined contribution plans

Prior to EGTRRA, the maximum amount an employer could contribute to a participant's account in a defined contribution plan (i.e. profit-sharing, 401(k), money purchase pension and stock bonus) was the lesser of 25 percent of the participant's compensation or $35,000. The $35,000 amount had just increased from $30,000 to $35,000 in the 2001 plan year due to a COLA increase. Prior to 2001, the limit had been $30,000 since 1982. Interestingly, before 1982 the limit was $45,475 which was subsequently reduced to $30,000 by the Tax Equity and Fiscal Responsibility Act of 1982.

Beginning in the 2002 plan year, EGTRRA amends IRC § 415(c) to increase the defined contribution plan annual addition limitations to the lesser of 100 percent of the participant's compensation or $40,000. The $40,000 amount is indexed for COLA and will...

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