MAJOR RETIREMENT SAVINGS PROVISIONS OF H.R. 1836*
Issue IRA CHANGES
IRA Contribution Limits Current Law H.R. 1836* The maximum annual contribution permitted to IRAs (traditional or Roth) is generally the lesser of $2,000 or 100% of the individual's compensation. The IRA contribution limit would be increased as follows: Year Limit 2002-2004 $3,000 2005-2007 $4,000 2008 $5,000 Thereafter, the limit would be indexed for inflation annually (in $500 increments). Individuals age 50 and over would be permitted to make catch-up contributions to IRAs as follows: Year Limit 2002-2005 $ 500 2006+ $1,000 Catch-Up Contributions Once an individual has missed the opportunity to make an IRA contribution for a given year, the individual has no opportunity to "catch-up" in later years. LIMITS ON RETIREMENT PLAN CONTRIBUTIONS AND BENEFITS
Maximum Salary Reduction Contribution (Section 402(g)) Section 402(g) limits elective deferrals under most salary reduction plans, (e.g., section 401(k) plans and section 403(b) arrangements) to $10,500 (in 2001). The limit on elective deferrals would be increased to $15,000 as follows: Year Limit 2002 $11,000 2003 $12,000 2004 $13,000 2005 $14,000 2006 $15,000 (indexed) The $35,000 dollar limit in section 415(c) would be increased to $40,000 beginning in 2002. Future indexing of this limit would be in $1,000 increments. [The 25% of compensation limit is modified as described below.] The section 401(a)(17) compensation limit would be increased to $200,000 beginning in 2002 (with future indexing in $5,000 increments). Defined Contribution Plan Limit (Section 415(c)) Section 415(c) currently limits maximum annual contributions to defined contribution plans on behalf of an individual to the lesser of 25% of compensation or $35,000. The $35,000 limit is indexed for inflation in $5,000 increments. Compensation Under section 401(a)(17) compensation that may be taken into Taken Into Account account in determining benefits under qualified plans is limited to (Section $170,000 (in 2001), indexed in $10,000 increments. In 1993, the 401(a)(17))) limit was $235,840. * H.R. 1836 passed the House and Senate on May 27, 2001 by votes of 240-154 and 58-33, respectively. The President is expected to sign legislation soon. ©Randy Hardock and John O'Neill ­ Davis & Harman LLP May 27, 2001 Issue Current Law H.R. 1836*
Effective for years ending after 12/31/01, the $140,000 dollar limit in section 415(b) would be increased to $160,000 Indexing would then continue as under current law (in $5,000 increments). Actuarial reduction of the section 415(b) dollar limit would be required only for benefit commencement prior to age 62. The limit on elective deferrals to plans governed by section 457(b) would be increased as follows: Year Limit 2002 $11,000 2003 $12,000 2004 $13,000 2005 $14,000 2006 $15,000 (indexed) Defined Benefit Maximum annual benefits under a defined benefit plan are Plan Limit (Section limited by section 415(b) to the lesser of 100% of three-year415(b)) high-average pay or $140,000 (in 2001). Actuarial reduction of the limit is required if benefits start prior to Social Security normal retirement age.
Section 457(b) Plan The dollar limit on contributions under eligible deferred Contribution Limit compensation plans under section 457(b) is generally $8,500 in 2001. SIMPLE Plan Contribution Limit (Section 408(p)) Maximum elective deferrals to SIMPLE retirement plans are The limit on elective deferrals to SIMPLE plans would be increased as follows: limited to $6,500 per year (in 2001), indexed for inflation in $500 Year Limit increments. 2002 $7,000 2003 $8,000 2004 $9,000 2005 $10,000 (indexed) ENHANCING FAIRNESS FOR WOMEN
Additional Salary The Code imposes annual limits on the maximum amount that Reduction Catch-up can be contributed by an employee to a section 401(k) plan, a Contributions section 403(b) arrangement, a SIMPLE plan, and certain other salary reduction arrangements. With certain limited exceptions, once an individual has missed the opportunity to make a contribution for a given year, the individual has no opportunity to "catch-up" in later years. Individuals age 50 or older would be allowed to make annual catch-up contributions to salary reduction arrangements of the following amounts: Year General SIMPLE 2002 $1,000 $ 500 2003 $2,000 $1,000 2004 $3,000 $1,500 2005 $4,000 $2,000 2006 $5,000 $2,500 Amounts are indexed for inflation beginning in 2007 (in $500 increments). Such catch-up contributions would not be subject to any other contribution limits and would not be subject to any nondiscrimination rules, except that plan would have to allow all eligible individuals to participate in the catch-up in the same manner. ©Randy Hardock and John O'Neill ­ Davis & Harman LLP -2- May 27, 2001 Issue Current Law H.R. 1836*
Beginning in 2002, the 25% of compensation limitation would be increased to 100%. The 33a% of compensation limit of section 457(b) would be increased to 100% of compensation. The MEA rules would be repealed. Increase Percentage Total annual additions to defined contribution plans for any of Salary employee is generally limits to the lesser of $30,000 or 25% of Limitations compensation. Generally, for section 457(b) plans, total annual contributions are limited to 33a% of compensation. Section 403(b) arrangements are also subject to a set of complex maximum exclusion allowance (MEA) rules. Employer contributions to most retirement plans either must be fully vested after the employee has completed five years of service, or must become vested in increments of 20% for each year beginning with the employee's third year of service, with full vesting after the employee has completed seven years of service. Faster Vesting of Employer Matching Contributions Beginning in 2002, employer matching contributions would be required either to be fully vested after an employee has completed three years of service or to become vested in increments of 20% for each year beginning with the employee's second year of service, with full vesting after the employee has completed six years of service. OTHER PROPOSALS INTENDED TO EXPAND COVERAGE AND BENEFITS GENERALLY
Credit for Low- and No provision. Middle-Income Savers A targeted non-refundable tax credit would be provided to low- and moderate-income savers who make salary reduction contributions to eligible retirement savings plans (e.g., 401(k), 403(b), 457(b), or IRAs). The credit would be claimed on the individual's tax return, and would apply to the first $2,000 in savings contributions. The amount of the credit would generally be based on the following AGI schedule: Credit Individual Joint 50% $0-$15,000 $0-$30,000 20% $15,001-$16,250 $30,001-$32,500 10% $16,251-$25,000 $32,501-$50,000 Contributions to eligible retirement savings plans would continue to be deductible or excludable from income as under current law. If a potential credit recipient (or such person's spouse) receives a pre-retirement distribution in any year, the ability to receive a government match in that year or in the two subsequent years will be reduced by the amount of the distribution. The credit would be available only from 2002-2006. ©Randy Hardock and John O'Neill ­ Davis & Harman LLP -3- May 27, 2001 Issue
Top-Heavy Rules Current Law
Section 416 establishes complicated testing rules for determining whether or not a plan is top-heavy (e.g., whether "key employees" are deemed to be receiving an excessive proportion of the plan benefits). Top-heavy plans are required to satisfy a special vesting schedule and make minimum contributions or accruals for "non-key" employees. Plans which are "super topheavy" must make additional minimum contributions or accruals and are subject to a lower aggregate limitation under section 415(e). H.R. 1836*
Beginning in 2002, the top heavy rules would be simplified in a variety of ways. For example, the following changes would be made: · Family aggregation rules would be modified for purposes of determining key employees, however, such rules would continue to apply for purposes of determining whether and individual is a 5% owner. · Key employee definition would be modified to include (1) an officer with compensation in excess of $130,000; (2) a 5% owner; and (3) a 1% owner with compensation in excess of $150,000. · Count matching contributions toward satisfying minimum contribution rules. · Look-back rules would be shortened. · Plans meeting the section 401(k); and section 401(m) design-based discrimination testing safe harbors would not be top-heavy. Certain small employers would be able to claim a non-refundable tax credit in connection with new retirement plans. The credit would apply to 50% of the first $1,000 in administrative and retirement-education expenses ("start-up expenses") for three years after establishing a new employment-based retirement plan and would be available to employers with 100 or fewer employees. No deduction would be allowed for the amount claimed as a credit. Credit would be available beginning for new plans established in 2002. PROPOSALS TARGETED PRIMARILY AT SMALL BUSINESSES Small Business Tax No provision. Credit for Administrative Expenses in Connection with New Retirement Plans Deduction Limit for Stock Bonus and Profit Sharing Plans An employer's deduction for contributions to a profit-sharing or The annual limitation on the amount of deductible contributions to a profitstock bonus plan is generally limited to 15% of the taxable sharing or stock bonus plan would be increased from 15% to 25% of compensation of the plan's participants. The limit on deductions compensation of the employees covered by the plan for the year. to other types of plans is generally 25%. INCREASING PORTABILITY FOR PARTICIPANTS
Rollovers Among Amounts in a section 401(a) plan or section 403(b) arrangement Various Types of generally may only be rolled over to the same type of plan or Employment-Based arrangement or to an IRA. Amounts in section 457(b) plans Retirement Plans Beginning in 2002, amounts in section 401(a) plans or section 403(b) arrangements, or section 457(b) plans maintained by a state or local government generally could be rolled over to another section 401 plan, a may only be transferred from one section 457(b) plan to another section 403(b) arrangement, a section 457(b) plan maintained by a state or local section 457(b) plan. government, or an IRA. ©Randy Hardock and John O'Neill ­ Davis & Harman LLP -4- May 27, 2001 Issue
Rollovers of AfterTax Contributions Current Law
Employees are allowed to make after-tax contributions to 401(k) and other plans. They are not permitted to rollover distributions of those after-tax contributions into an IRA or another plan. Rollovers of amounts originally contributed directly into an IRA ("contributory IRAs") into any type of employment-based plan generally are not allowed. In some cases, 401(k) plan distributions are limited to separation from service with the employer. The term "separation from service" has been interpreted to not include a situation where the employee performs the same functions for a successor employer (the "same desk" rule). The same desk rule also applies to section 403(b) and 457(b) arrangements. Under State law, employees of State and local governments often have the option of purchasing service credits in their State defined benefit pension plans. Employees cannot use money in section 403(b) arrangements or section 457(b) plans to purchase service credits. H.R. 1836*
Beginning in 2002, after-tax employee contributions could be rolled over to other plans and IRAs. Rollovers From Contributory IRAs To Qualified Plans "Same Desk Rule" Repeal Beginning in 2002, contributory IRA amounts could be rolled over to a section 401(a) plan, a section 403(b) arrangement, a section 457(b) plan maintained by a state or local government, or another IRA. Beginning in 2002, the "same desk rule" would be eliminated by replacing "separation from service" in section 401(k)(2)(B) with "severance from employment." Conforming changes would be made for 403(b) arrangements and section 457(b) plans. Purchase of Service Credit in Government Defined Benefit Plans Beginning in 2002, State and local government employees would be able to use funds from their section 403(b) arrangements or section 457(b) plans to purchase service credits. OTHER PROPOSALS STRENGTHENING PENSION SECURITY, EDUCATION AND ENFORCEMENT
Repeal of Funding Limit Contributions to a defined benefit plan are not deductible to the extent that plan assets exceed the lesser of (1) 160% (in 2001) of the plan's current liability, or (2) a limitation based on a reasonable projection of benefits. The 160% figure is scheduled be phased up to 170% by the year 2005. Under ERISA section 204(h), a defined benefit plan or a money purchase pension plan may not be amended in a manner that results in a significant reduction in the rate of future benefit accrual unless, after the adoption of the plan amendment (and not less than 15 days before the effective date of the plan amendment), the plan administrator provides a written notice to affected participants and alternate payees. The notice must either (1) specify the plan amendment and its effective date, or (2) contain a summary of the amendment and effective date, written
-5- The full funding limit would be 165% of current liability for plan years beginning in 2002, 170% in 2003, and repealed in 2004 and after. Additional Disclosure Re: Significant Reduction in Benefit Accruals (Including Cash Balance Plan Conversions) A defined benefit plan or money purchase pension plan would be required to provide participants with a written notice concerning a plan amendment that provides for a significant reduction in future benefit accruals under the plan (including any elimination or reduction of an early retirement benefit). The Secretary of the Treasury could exempt or provide a simplified form of notice for a plan which has fewer than 100 participants who have accrued a benefit under the plan or which offers participants the option to choose between the new benefit formula and the old benefit formula. ©Randy Hardock and John O'Neill ­ Davis & Harman LLP May 27, 2001 Issue Current Law
in a manner calculated to be understood by the average plan participant and contains the effective date. H.R. 1836*
The notice would be required to describe the benefit reduction caused by the plan amendment in a manner calculated to be understood by the average plan participant, and generally would have to be provided within a reasonable time period prior to the effective date of the plan amendment. The penalty for failure to comply with the notice requirements would equal $100 per day per omitted party with a maximum penalty of $500,000 in any year (except in cases of willful neglect). The Secretary of the Treasury could waive this penalty if reasonable cause for failure is shown. Also, ERISA is amended to provide that plan amendment providing for a significant reduction in the rate of future benefit accruals will not be permitted where there has been an egregious failure by the plan administrator to comply with the notice requirements. Also, the current ERISA notice requirement is expanded to early retirement benefits. The changes with respect to notices of significant benefit reductions apply to plan amendments that take effect after the date of enactment, although transitional relief is provided. Regulations are required within 90 days of enactment. A study on cash balance conversions is required within 60 days after the date of enactment. Treatment of Multiemployer Plans Under Section 415 Under section 415(b), annual benefits payable under a defined benefit plan are limited to the lesser of $140,000 (for 2001) or 100% of "three-year-high-average compensation." A reduction in the dollar or percentage limit for defined benefit plans may be required if the employee has fewer than ten years of plan participation or service. Plans maintained by state & local governments are generally exempt from the 100% of compensation limit Dividend deductions are allowed under section 404(k) on dividends paid on employer stock to an unleveraged ESOP only if the dividends are paid to employees in cash; the deduction is denied if the dividends remain in the ESOP for reinvestment. Beginning in 2002, the section 415(b) limits applicable to multiemployer plans would be modified to eliminate the 100% of compensation limit (but not the dollar limit) for such plans. With respect to aggregation of multiemployer plans with other plans, multiemployer plans would not be aggregated with single-employer defined benefit plans maintained by an employer contributing to the multiemployer plan for purposes of applying the 100% of compensation limit to such single-employer plan. Beginning in 2002, an employer would be allowed to deduct dividends paid to an ESOP when its employees are allowed to elect to take the dividends in cash or leave them in the plan for reinvestment in employer stock. The Secretary of the Treasury would be able to disallow the deduction for any ESOP dividend if it is determined that such divided constitutes an avoidance or evasion of tax. For this purpose, the Secretary of the Treasury's authority includes the authority to disallow dividend deduction for unreasonable dividends.
May 27, 2001 ESOP Dividends May Be Reinvested Without Loss of Dividend Deductions ©Randy Hardock and John O'Neill ­ Davis & Harman LLP -6- Issue
Automatic Rollovers of Certain Mandatory Distributions Current Law
A plan may provide for the automatic distribution ("cash-out") of certain vested accrued benefits that do not exceed $5,000. The plan is not required to rollover such amounts to another retirement savings vehicle. H.R. 1836*
A plan that provides mandatory "cash-outs" of vested accrued benefits would be required to directly transfer such distributions to an IRA ("default IRA")or other qualified retirement vehicle unless the participant affirmatively elects to receive the distribution directly. The proposal would not apply to distributions of $1,000 or less. Limited fiduciary relief is provided to plan fiduciary with respect to the selection of the default IRA. The Department of Labor (DOL) is directed to issue safe harbors with respect to the designation of an institution and investment of funds. The provision is not effective until final DOL regulations are published, and such regulations must be finalized not later than three years after the date of enactment. Generally, includes a variety of provisions simplifying law. All provisions of the bill do not apply to taxable, plan or limitation years beginning after December 31, 2010. Other Provisions Sunset A number of complex and often counter-intuitive rules apply to employment-based retirement plans. The Budget Act creates a supermajority point of order against provisions in a budget reconciliation bill that lose revenue after the initial 10-year period. ©Randy Hardock and John O'Neill ­ Davis & Harman LLP -7- May 27, 2001