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May 29, 2001

Overview of Title VI of HR 1836,
as Passed by Congress

H.R. 1836, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), was passed by Congress on May 26, 2001.
The president will sign it shortly. It makes large cuts in federal income tax rates, reduces and then repeals the federal estate tax, and takes steps toward relieving the "marriage penalty" for low- and middle-income taxpayers. Also included, in Title VI, is much of the pension reform package that Congress has been working on for the past several years.

These changes will generally be effective starting with the first year or plan year beginning after December 31, 2001, with exceptions indicated. For federal budget purposes, all of the provisions of this new tax law will expire on September 30, 2010. Most of them - especially the pension changes - are generally expected to be renewed before then.

This Compliance Alert summarizes the provisions in H.R. 1836 that are most likely to be of interest to sponsors of employer-funded retirement plans. (The provisions are marked to indicate the types of plan sponsors for which they are most likely to be of interest: C for corporate, PS for public sector and M for multiemployer.)

1. Retirement Plan Limits, in General

• Section 415 defined-benefit dollar limit increased to
  $160,000 at age 62, with late-retirement adjustments
  for benefits starting after age 65, then indexed in $5,000 increments - C, PS, M
• Section 415 defined-contribution dollar limit increased to $40,000/year, then indexed in $1,000 increments - C, M
• Section 415 defined-contribution pay-based limit increased
  to 100 percent of pay - C, PS, M
• Section 401(a)(17) limit on pay that can be counted for pension purposes increased to $200,000/year, then indexed
  in $5,000 increments - C, PS, M
• Section 401(k) and 403(b) annual limit on elective deferrals increased, over 5 years, to $15,000 in 2006, then indexed in $500 increments - C, PS, M
• Section 457 annual limit on elective deferrals increased,
  over 5 years, to $15,000 in 2006, then indexed in $500 increments - C, PS
• Section 457 plan pay-based limit increased to 100 percent
  of pay - C, PS
• Section 403(b) maximum exclusion allowance repealed
  - C, PS
• Coordination of the section 415 and 457 limits repealed
  - C, PS

2. Multiemployer Section 415 Limits

• 100 percent-of-pay limit repealed, for multiemployer
  defined benefit plans - M
• Multiemployer plan benefits would no longer need to be aggregated with single-employer benefits funded by the
  same employer, when applying the 100 percent-of-pay
  limit to single employer defined benefit plans - M

3. Deduction Limits

• Employees' pre-tax contributions to section 401(k) plans would not be counted against the employer-contribution deduction limits - C, M
• Deduction limit for contributions to profit-sharing and
  stock bonus plans raised to 25 percent of covered
  participants' compensation, and applied to money
  purchase plans as well - C, M
• Compensation" for purposes of the deduction limits would include salary-reduction amounts under cafeteria plans and 401(k) plans - C, M
• Full-funding limit based on current liability phased-out
  by 2004 - C, M
• Notwithstanding other deduction limits, defined benefit
  plan contributions up to the full amount of current liability would be fully deductible, in the case of contributions to multiemployer plans and, - with some restrictions - single employer plans with 100 or fewer participants. (For small plans, recent benefit increases for highly compensated employees are disregarded when determining current liability.) - C, M
• Contributions made to a terminating single employer defined benefit plan to make the plan sufficient are fully deductible, subject to above the restrictions related to certain benefit increases in small plans - C
• Defined contribution plan contributions up to 6 percent of participants' pay (or, if greater, the sum of participants' pre-tax contributions plus employer matching contributions) would be disregarded, in applying the excise tax for going over the 25% deduction limit for a combination of defined contribution and defined benefit plans - C, M
• The excise tax on non-deductible contributions can be determined without regard to contributions to defined benefit plans, up to the full funding limit - C, M
• ESOP dividends will be deductible even if automatically reinvested in employer stock - C
• There will be no excise tax on nondeductible contributions
  to a SIMPLE plan on behalf of household workers that the employer cannot deduct because they are not business expenses - C
• A provision labeled "Clarification of Treatment of Contributions to Multiemployer Plans" is intended to provide relief for certain employers from technical IRC accounting rules in narrowly targeted circumstances, and should affect few plans and contributing employers - M

4. Portability

• Tax-free rollovers would be allowed among governmental section 457 plans, section 403(b) plans and qualified plans under section 401(a) - C, PS
• Distributions from IRAs could be rolled over to employer-sponsored plans - C
• Employees' after-tax contributions could be rolled over
  to defined contribution plans or to IRAs that are willing
  to account for them separately after the rollover - C, PS
• In the case of a mandatory small-benefit cashout that is
  more than $1,000, the funds must be transferred to an
  IRA unless the participant explicitly directs otherwise.
  This requirement will not take effect until the Labor
  Department issues final regulations prescribing safe
  harbor methods for handling this distribution that will
  shield plan sponsors from fiduciary responsibility - C, M, PS
• Defined contribution plans could eliminate all payment
  options other than lump sums - C, M
• IRS would be directed to issue regulations authorizing elimination of defined benefit payment options and subsidies that "create significant burdens or complexities," but only
  if it does not adversely affect the rights of participants in a more than de minimis manner - C, M
• The "same desk rule" would be repealed, to the extent
  it applies to section 401(k) plans affected by corporate transactions - C
• Trustee-to-trustee transfers from section 403(b) or
  457 plans could be used for the purchase of service
  credit under governmental defined benefit plans - PS
• The constructive-receipt concept would not apply to distributions available under governmental section 457
  plans - PS

5. Pension Nondiscrimination

• Top-heavy rules would be streamlined and simplified - C
• In the case of a controlled group that is partly tax exempt and partly taxable, the minimum coverage rules would be modified to allow the taxable enterprise to offer a section 401(k) plan while the tax exempt operations maintain their section 403(b) program - C
• The "multiple use" test for section 401(k) plans that include matching employer contributions would be repealed - C

6. Participant Communications

• Section 204(h) is amended to require notice and an
  explanation of the effect of an amendment to a defined
  benefit or money purchase plan that significantly reduces
  the rate of future benefit accruals or that eliminates or significantly reduces early retirement benefits or retirement-type subsidies, and an excise tax penalty is added that is similar to the COBRA excise tax penalty; IRS can modify
  or eliminate the notice in the case of small plans (under
  100 participants) or those that offer participants a choice
  between the old and new formulas. Where required,
  the notice is to be given within a reasonable time before
  the change takes effect - C, M

  *NOTE: this expanded notice requirement applies to plan amendments that take effect after the date the President
  signs H.R. 1836, but notices that meet the new standards
  do not have to be given until 3 months after that date.

• Employer-provided retirement planning services could be provided tax-free to employees - C, PS, M

7. New Deferred Savings Opportunities

• Employees over age 50 can make catch-up salary-reduction contributions to 401(k), 403(b) and governmental 457 plans, which will be over and above the section 401(k), 415 and
  other limits. The maximum amount of these additional contributions is phased in from 2002 to 2006 in $1,000 increments, and, once the limit reaches $5,000, is to be indexed (in $500 increments) thereafter. These makeup contributions will be exempt from the nondiscrimination requirements (general and 401(k) ADP tests) as long
  as the opportunity to make them is offered to all eligible participants - C, PS, M
• Low- to moderate-income individuals (making up to $50,000,
  in the case of a joint return) will get a federal income tax
  credit to match part of their salary-reduction contributions to 401(k), 403(b) or governmental 457 plans, or to IRAs, up to $2,000. The size of the credit declines from 50% to 10% as the person's income increases. The credit is not available to students, people claimed as other taxpayers' dependents,
  and those who have recently withdrawn funds from a qualified plan or IRA - C, PS, M
• Starting in 2006, employers can offer "Roth 401(k) plans" comparable to Roth IRAs, through which employees could make after-tax contributions and withdraw the earnings tax-free under specified circumstances - C, PS
• Employer-funded plans can offer separate deductible employee contribution accounts, which will be subject to
  the IRA restrictions and deduction limits and treated as
  IRAs rather than benefits under the plan for all other
  purposes as well - C, PS
• Annual IRA contribution limits are increased to $3,000 in
  2002, $4,000 in 2005 and $5,000 in 2008 - C, PS

8. Small Plan Incentives

• IRS user fees for determination letters would be waived,
  for filings made within the first 5 years of a retirement plan sponsored by a small employer (under 100 employees) - C
• A small employer - one with no more than 100 employees (counting the whole controlled group as one employer) - that adopts a qualified plan after 2001 will be eligible for a federal income tax credit of up to $500 (for each of the first 3 years) against the costs of establishing or administering the plan or providing retirement-related education to the eligible employees. This credit is available only if the employer has not sponsored a plan for the same employee group for at least 3 years before the year for which the credit is claimed, and only if the plan covers at least one non-highly compensated employee - C, M

9. Other Retirement Savings Provisions

• Self-employed people and partners would be allowed to take participant loans from their firms' qualified plans - C
• Employer matching contributions to section 401(k) plans would have to vest on either a 3-year cliff or 2 - 6 year graduated schedule - C [there is a delayed effective date, linked to the bargaining-agreement cycle, for collectively bargained plans]

• The IRS is directed to update the mortality tables used
  to calculate minimum distributions from qualified plans
  and IRAs - C, PS, M
• Distributions to alternate payees from section 457 plans
  would be taxed like distributions from qualified plans
  under QDROs - PS
• Special rules would be added for stock allocations under ESOPs sponsored by Subchapter S corporations - C
• While annual valuations are still required for defined benefit plans, the valuation can, at the plan sponsor's option, be based on data as of a date within the prior plan year if, as of that date, the plan's assets were at least 125 percent of its current liability - C, M
• The safe harbor for hardship distributions from 401(k) plans would be modified to enable employees to resume pretax contributions after 6 months - C, PS, M

* * *

As always, plan sponsors should look to their attorneys for specific advice on how changes in the law could affect them.

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