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New Changes in Retirement Plan Law

Part 2: General Pension Provisions

Anthony Mathews

July 2001

Last month, we started with a discussion of the ESOP-related provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001. ESOP sponsors may well benefit more from the general pension provisions of the new law than from the specific ESOP provisions. These changes loosen the limitations that have occupied a significant portion of the planning energy that goes into creating ESOPs or any other qualified retirement plans.

To begin with some dramatic improvements in the funding potential of defined contribution plans (like profit sharing plans, stock bonus plans, ESOPs, and 401(k) plans), the bill contains provisions that significantly ease the limitation conflicts we have grown so used to over the years:

For years beginning after 12/31/01, the basic defined contribution plan deduction limit will be increased from 15% to 25% of covered compensation. To date, in order to get an overall deduction limit of 25%, one either had to be a leveraged ESOP (in a C-corporation, qualified for the extraordinary ESOP deduction limits) or to add a fixed contribution portion (usually referred to as a money purchase pension portion) requiring an annual contribution of no less than 10% of pay.
Also for plan years beginning after 2001, the 401(a)(17) maximum amount of compensation that may be taken into account (for any purpose) in qualified plans increases to $200,000 and is then intended to be indexed in $5,000 increments thereafter.
Probably the most significant amendment in the package is the increase in the individual allocation limitation. For limitation years beginning after December 31, 2001, the 415(c) defined contribution limit on total annual additions to the accounts of any individual in all qualified defined contribution plans sponsored by an employer is increased to the lesser of 100% of compensation (up from 25%) or $40,000 (up from $30,000). The dollar limit is then scheduled to be indexed in $1,000 increments thereafter.
The new law contains a provision requiring that involuntary cash-outs of benefits in excess of $1,000 will have to be automatically rolled over to an employer-designated IRA unless the participant affirmatively elects to receive the amount in cash or directs the amount be rolled over to another plan or IRA. This could presumably help with the issue of the unlocatable participant, but the potential administrative problems far outweigh that potential. Fortunately, the Department of Labor is directed to prescribe safe harbor investments for this purpose through regulations, and the provision will not become effective until after these regulations are issued.
Of interest to S corporations perhaps, participant loans to partners and certain S corporation shareholders (currently prohibited) will be allowed beginning in 2002.
Related to top-heavy plans, probably the most significant change provides that a "safe harbor" 401(k) (elective deferral) plan or a safe harbor 401(m) (matching contribution) plan is not top-heavy on its own, and contributions may be taken into account in determining the treatment of any other aggregated plan. Other top-heavy-related provisions include:
- The top-heavy five-year lookback rule is repealed effective in 2002.
- The five- year look back rule for adding back distributions in determining key employee account balances is shortened to one year, except for in-service distributions effective in 2002.
- The dollar threshold for determining who is a "key employee" among officers is increased to $130,000 and scheduled to be adjusted thereafter in the same manner as the 415 limit in $5,000 increments.
- Frozen defined benefit plans will no longer have to make top-heavy minimum accruals.
Portability provisions allowing rollovers between defined contribution vehicles without restrictions and allowing rollovers from IRAs to workplace retirement plans are effective in 2002.

Next month: 401(k), defined benefit, and small plan provisions

Biography and list of other "Administrator's Notebook" installments

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