Retirement Plan Provisions

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Retirement Plan Provisions
(Included in Tax Bill - Part 1 - 05/30/2001)


Legislation; Code Section None
Wednesday, May 30, 2001
The tax bill passed May 26 makes extensive changes to retirement plan provisions, most of which are effective beginning in 2002.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (the Bill) passed by Congress May 26 makes extensive changes to retirement plan tax provisions. Among the changes included in the Bill are the following: (1) increased contribution limits and catch-up contributions to IRAs; (2) provisions for expanding coverage, including increased contribution and benefit limits for qualified plans, increases in elective deferral limits, and a credit for certain elective deferrals and IRA contributions; (3) provisions to enhance fairness for women, including additional catch-up contributions for individuals over age 50; (4) provisions for increasing portability for plan participants; (5) provisions for strengthening pension security and enforcement; and (6) provisions for reducing regulatory burdens. The article below discusses items (1) and (2). The provisions related to items (3) through (6) will be discussed in upcoming articles.

INDIVIDUAL RETIREMENT ARRANGEMENTS

Modification of IRA Contribution Limits

The Bill increases the maximum annual dollar contribution limit for IRA contributions from $2,000 to $3,000 for 2002 through 2004, $4,000 for 2005 through 2007, and $5,000 for 2008. After 2008, the limit is adjusted annually for inflation in $500 increments. The Bill also provides that individuals who have attained age 50 may make additional catch-up IRA contributions. The otherwise maximum contribution limit (before application of the AGI phase-out limits) for an individual who has attained age 50 before the end of the taxable year is increased by $500 for 2002 through 2005, and $1,000 for 2006 and thereafter.

Deemed IRAs under Employer Plans

For tax years beginning after 2002, the Bill provides that, if an eligible retirement plan permits employees to make voluntary employee contributions to a separate account or annuity that (1) is established under the plan, and (2) meets the requirements applicable to either traditional IRAs or Roth IRAs, then the separate account or annuity is deemed a traditional IRA or a Roth IRA, as applicable, for all purposes of the Code. For example, the reporting requirements applicable to IRAs apply. The deemed IRA, and contributions thereto, are not subject to the Code rules pertaining to the eligible retirement plan. In addition, the deemed IRA, and contributions to that deemed IRA, are not taken into account in applying such rules to any other contributions under the plan. The deemed IRA, and contributions, are subject to the exclusive benefit and fiduciary rules of ERISA to the extent otherwise applicable to the plan, and are not subject to the ERISA reporting and disclosure, participation, vesting, funding, and enforcement requirements applicable to the eligible retirement plan. An eligible retirement plan is a qualified plan (Code Section 401(a)), tax-sheltered annuity (Code Section 403(b)), or a governmental Code Section 457 plan.

EXPANDING COVERAGE

Contribution Limits

Effective for years beginning after 2001, the Bill increases the limits on contributions and benefits under qualified plans, the amount of compensation that may be taken into account under a plan for determining benefits, the amount of elective deferrals that an individual may make to a salary reduction plan or tax sheltered annuity, and deferrals under an eligible deferred compensation plan of a tax-exempt organization or a state or local government.

Specifically, the Bill increases the $35,000 limit on annual additions to a defined contribution plan to $40,000. This amount is indexed in $1,000 increments. The Bill also increases the $140,000 annual benefit limit under a defined benefit plan to $160,000. The dollar limit is reduced for benefits beginning before age 62 and increased for benefits beginning after age 65.

The Bill increases the limit on compensation that may be taken into account under a plan to $200,000. This amount is indexed in $5,000 increments. The Bill also amends the definition of compensation for purposes of all qualified plans and IRAs (including Savings Incentive Match Plan for Employees (SIMPLE) arrangements) to include an individual's net earnings that would be subject to Self-Employment Contribution Act (SECA) taxes but for the fact that the individual is covered by a religious exemption.

The Bill increases the dollar limit on annual elective deferrals under Code Section 401(k) plans, Code Section 403(b) annuities and salary reduction simplified employee pension plans (SEPs) to $11,000 in 2002. In 2003 and thereafter, the limits are increased in $1,000 annual increments until the limits reach $15,000 in 2006, with indexing in $500 increments thereafter. The Bill increases the maximum annual elective deferrals that may be made to a SIMPLE plan to $7,000 in 2002. In 2003 and thereafter, the SIMPLE plan deferral limit is increased in $1,000 annual increments until the limit reaches $10,000 in 2005. Beginning after 2005, the $10,000 dollar limit is indexed in $500 increments.

The Bill increases the dollar limit on deferrals under a Code Section 457 plan to conform to the elective deferral limitation. Thus, the limit is $11,000 in 2002, and is increased in $1,000 annual increments thereafter until the limit reaches $15,000 in 2006. The limit is indexed thereafter in $500 increments. The limit is twice the otherwise applicable dollar limit in the three years before retirement.

Plan Loans for S Corporation Shareholders, Partners, and Sole Proprietors

Certain transactions (i.e., prohibited transactions) between a qualified plan and a disqualified person are prohibited in order to prevent persons with a close relationship to the qualified plan from using that relationship to the detriment of plan participants and beneficiaries. Certain types of transactions are exempted from the prohibited transaction rules, including loans from the plan to plan participants, if certain requirements are satisfied. The statutory exemptions to the prohibited transaction rules do not apply to certain transactions in which the plan makes a loan to an owner-employee. A two-tier excise tax is imposed on disqualified persons who engage in a prohibited transaction. For purposes of the prohibited transaction rules, an owner-employee means (1) a sole proprietor, (2) a partner who owns more than 10 percent of either the capital interest or the profits interest in the partnership, (3) an employee or officer of a Subchapter S corporation who owns more than 5 percent of the outstanding stock of the corporation, and (4) the owner of an individual retirement arrangement (IRA). The term owner-employee also includes certain family members of an owner-employee and certain corporations owned by an owner-employee.

Effective for tax years beginning after 2001, the Bill generally eliminates the special rules relating to plan loans made to an owner-employee (other than the owner of an IRA). Thus, the general statutory exemption applies to such transactions.

Modification of Top-Heavy Rules

Additional qualification requirements apply to plans that primarily benefit an employer's key employees (top-heavy plans). These additional requirements provide (1) more rapid vesting for plan participants who are non-key employees and (2) minimum nonintegrated employer contributions or benefits for plan participants who are non-key employees.

Effective for tax years beginning after 2001, the Bill provides that a plan consisting of a cash-or-deferred arrangement that satisfies the design-based safe harbor for such plans and matching contributions that satisfy the safe harbor rule for such contributions is not a top-heavy plan. An employee is considered a key employee if, during the prior year, the employee was (1) an officer with compensation in excess of $130,000 (adjusted for inflation in $5,000 increments), (2) a 5 percent owner, or (3) a 1 percent owner with compensation in excess of $150,000. The present-law limits on the number of officers treated as key employees under (1) continue to apply. The family ownership attribution rule continues to apply in determining whether an individual is a 5 percent owner of the employer for purposes of the top-heavy rules.

Elective Deferrals

Employer contributions to one or more qualified retirement plans are deductible subject to certain limits. For purposes of the deduction limits, employee elective deferral contributions to a Code Section 401(k) plan are treated as employer contributions and, thus, are subject to the generally applicable deduction limits. Subject to certain exceptions, nondeductible contributions are subject to a 10-percent excise tax.

Effective for tax years beginning after 2001, elective deferral contributions are not subject to the deduction limits, and the application of a deduction limitation to any other employer contribution to a qualified retirement plan does not take into account elective deferral contributions.

Under the Bill, effective for tax years beginning after 2005, a Code Section 401(k) plan or a Code Section 403(b) annuity is permitted to include a contribution program that permits a participant to elect to have all or a portion of the participant's elective deferrals under the plan treated as Roth contributions. Roth contributions are elective deferrals that the participant designates as not excludable from the participant's gross income. The annual dollar limitation on a participant's Roth contributions is the Code Section 402(g) annual limitation on elective deferrals, reduced by the participant's elective deferrals that the participant does not designate as Roth contributions. Roth contributions are treated as any other elective deferral for purposes of nonforfeitability requirements and distribution restrictions.

Non-Refundable Credits for Certain Contributions, Elective Deferrals, and Pension Plan Start-Up Costs

Effective for tax years beginning after 2001 and before 2007, the Bill provides a temporary nonrefundable tax credit for contributions made by eligible taxpayers to a qualified plan. The maximum annual contribution eligible for the credit is $2,000. The credit rate depends on the adjusted gross income (AGI) of the taxpayer. Only joint returns with AGI of $50,000 or less, head of household returns of $37,500 or less, and single returns of $25,000 or less are eligible for the credit. The AGI limits applicable to single taxpayers apply to married taxpayers filing separate returns. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit is available to individuals who are 18 or over, other than individuals who are full-time students or claimed as a dependent on another taxpayer's return.

The credit is available with respect to elective contributions to a Code Section 401(k) plan, Code Section 403(b) annuity, or eligible deferred compensation arrangement of a state or local government, SIMPLE, or SEP, contributions to a traditional or Roth IRA, and voluntary after-tax employee contributions to a qualified retirement plan. The present-law rules governing such contributions continue to apply. The amount of any contribution eligible for the credit is reduced by taxable distributions received by the taxpayer and his or her spouse from any savings arrangement described above or any other qualified retirement plan during the taxable year for which the credit is claimed, the two taxable years prior to the year the credit is claimed, and during the period after the end of the taxable year and prior to the due date for filing the taxpayer's return for the year. In the case of a distribution from a Roth IRA, this rule applies to any such distributions, whether or not taxable.

The credit rates based on AGI are as follows:

Joint Filers

Heads of Households

All Other Filers

Credit Rate


$0-30,000

$0-22,500

$0-15,000

50%


$30,000-32,500

$22,500-24,375

$15,000-16,250

20%


$32,500-50,000

$24,375-37,500

$16,250-25,000

10%


Over $50,000

Over $37,500

Over $25,000

0%


The Bill also provides a nonrefundable income tax credit for 50 percent of the administrative and retirement-education expenses for any small business that adopts a new qualified defined benefit or defined contribution plan (including a Code Section 401(k) plan), SIMPLE plan, or SEP. The credit applies to 50 percent of the first $1,000 in administrative and retirement-education expenses for the plan for each of the first three years of the plan. The credit is available to an employer that did not employ, in the preceding year, more than 100 employees with compensation in excess of $5,000. In order for an employer to be eligible for the credit, the plan must cover at least one nonhighly compensated employee. In addition, if the credit is for the cost of a payroll deduction IRA arrangement, the arrangement must be made available to all employees of the employer who have worked with the employer for at least three months. The credit is a general business credit. The 50 percent of qualifying expenses that are effectively offset by the tax credit are not deductible; the other 50 percent of the qualifying expenses (and other expenses) are deductible to the extent permitted under the law. This provision is effective with respect to costs paid or incurred in taxable years beginning after 2001, with respect to plans established after such date.

Elimination of User Fee for Certain Employers

Under the Bill, a small employer (100 or fewer employees and at least one nonhighly compensated employee who is a plan participant) is not required to pay a user fee for a determination letter request with respect to the qualified status of a retirement plan that the employer maintains if the request is made before the later of (1) the last day of the fifth plan year of the plan or (2) the end of any applicable remedial amendment period with respect to the plan that begins before the end of the fifth plan year of the plan. In addition, determination letter requests for which user fees are not required under the Bill are not taken into account in determining average user fees. The Bill applies only to requests by employers for determination letters concerning the qualified retirement plans they maintain. Therefore, a sponsor of a prototype plan is required to pay a user fee for a request for a notification letter, opinion letter, or similar ruling. A small employer that adopts a prototype plan, however, is not required to pay a user fee for a determination letter request with respect to the employer's plan. This provision is effective for determination letter requests made after 2001.