Summary of Retirement Plan Issues in the Economic Growth and Tax Relief Reconciliation Act of 2001*

by
Kristi Cook, J.D.
co-author of 403(b) and 457(b) Primer Plus

On May 27, 2001, H.R. 1836, the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") was passed by both the House and Senate. It was signed by the president soon after. In general, the provisions of the bill become affective for years beginning after December 31, 2001, with few exceptions. Those exceptions are clearly indicated in bold text. To avoid filibusters and amendment proposals that could unduly delay the passage of the bill, it is scheduled to sunset in 10 years. That means that all of the provisions described below will terminate on January 1, 2012. However, it is expected that these provisions will be made permanent before the expiration in 10 years.
Provisions Current Law New Law
IRA Contribution Limit The maximum IRA contribution is the lesser of $2,000 or 100% of compensation $3,000 in 2002-2004
$4,000 in 2005-2007 
$5,000 in 2008 and later years
indexed in $500 increments thereafter
New IRA "Catch up" for aged 50+ No "catch up" opportunities for missed contributions For individuals aged 50 or more, the contribution limit is increased by $500 from 2002-2005 and by $1,000 thereafter.
403(b) and 401(k) Elective Deferral Limits The current deferral limit is $10,500. Employees of qualified employers may contribute up to an additional $3,000/year after 15 years of service. $11,000 in 2002
$12,000 in 2003
$13,000 in 2004
$14,000 in 2005
$15,000 in 2006

indexed in $500 increments thereafter
457 Salary Reduction Limits The current contribution limit for 457(b) plans is the lesser of 33 1/3% of pay or $8,500 per year. the limit increases to $15,000 in the final three full years before retirement. The limit for contributions to 457 plans is the lesser of 100% of compensation or:
$11,000 in 2002
$12,000 in 2003
$13,000 in 2004
$14,000 in 2005
$15,000 in 2006
indexed in $500 increments thereafter

 
SIMPLE Contribution Limits The current deferral limit is $6,500. $ 7,000 in 2002
$ 8,000 in 2003
$ 9,000 in 2004
$10,000 in 2005
indexed in $500 increments thereafter
*This summary generally explains provisions of EGTRRA as they affect the tax exempt and governmental retirement plan marketplace. However, since many product providers and sales representatives also have retirement products or clients in the "for profit" marketplace, I have included some important provisions affecting those plans.
Provisions Current Law New Law
"Catch up" opportunities for individuals aged 50 or greater No provisions under current law to make up for missed contributions. For individuals aged 50 or more who participate in 403(b), 401(k), governmental 457(b) plans or SIMPLE plans, the contribution limit is increased as follows:

Year         403(b)/401(k)/457(b)      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

In 401(k) plans, "catch up" contributions are not considered when applying the ADP test
Maximum exclusion Allowance (MEA) 403(b) plans are not permitted to exclude from gross income amounts that exceed the individual's allowance. Repealed in 2002.

For 2000 and 2001, the MEA is amended to eliminate prior defined benefit contributions from the "prior contributions" portion of the MEA calculation.
415(c) Limit Currently, the lesser of 25% of compensation of $35,000. Employees of qualified employers offering 403(b) plans are eligible to use special A, B and C elections to increase the normal limit. Lesser of $40,000 or 100% of compensation and indexed in $1,000 increments thereafter

Special A, B, and C elections are repealed.
403(b) and 401(a) Aggregation under 415(c) Currently, 403(b) and other defined contribution plans are not aggregated unless the employee "controls" his employer or is using Special election "C" under section 415(c)(4) of the code. Unfortunately, it is unclear what the result would be under the new bill. The language is very ambiguous on this point. One view is that the language in the new bill is merely a technical correction necessary after the repeal of section 415(e). The other view is that the language of the new law imposes mandatory aggregation, even if that was not intended. The IRS has taken no position on this issue to date.

 
403(b)/401(k) and 457(b) Deferral offsets 457(b) limits are reduced by any amounts contributed into a 403(b) and/or 401(k) plan. Elective deferrals to 403(b) or 401(k) plans would not count against 457(b) plan contributions. 457(b) plans have separate limits which are not reduced by employee contributions into either a 401(k) plan or a 403(b) plan.
Compensation for Benefits Purposes Currently $170,000 $200,000, and indexed in $5,000 increments thereafter



Provisions Current Law New Law
Roth-Type 403(b) and 401(k) Plans No provisions under current law for "Roth" type contributions into 403(b) or 401(k) plans. Only Roth IRAs are permitted.

Employees could elect to treat all or any portion of their elective deferrals into 403(b) or 401(k) plans as Roth contributions with rules similar to Roth IRA contributions.

  • For 401(k) plans, the Roth-type employee contributions are included as "pre-tax" contributions for purposes of the ADP test
  • Separate accounts required for Roth and nonRoth contributions to the same plan
  • This provision is not effective until 2006
Pension Portability Currently, amounts in qualified plans and 403(b) plans may only be rolled over into plans of the same type, or into IRAs. 457(b) plans may not be rolled over into any type of plan or IRA. Rollovers from 401, 403(b), governmental 457(b) plans and IRAs may be made into any other 401, 403(b), governmental 457(b) plan or IRA without regard to the type of plan distributing the rollover.
  • Amounts rolled into a governmental 457(b) plan from an IRA, 401(a) or 403(b) would be subject to the 10% early distribution penalty tax.
  • Amounts originally contributed into an IRA may be rolled over into qualified plans, 403(b) and governmental 457(b) plans.
  • Surviving spouses could rollover distributions into their own 401, 403(b), IRA or governmental 457(b) plan.
After-Tax Contributions After-Tax contributions may not be rolled over. After-Tax contributions may be rollover into any other eligible plan or IRA
403(b) and 457 But Back of Past Service Credits No provision. Employees of governmental employers may transfer assets from 403(b) and/or 457(b) accounts to state defined benefit plans to purchase past service credits.
Retiree Contributions to 403(b) Plans No statutory provision, however there are two private letter rulings that permit post retirement 403(b) contributions under certain circumstances. Employers are permitted to make contributions into 403(b) plans for terminated employees for a period of up to 5 years, using final 12-month salary as basis for post employment 415(c) limitation calculations.
Distributable Event Changes Distributions from 403(b), 401(k) and 457(b) plans may be made upon a participant's "separation for the service" Distributions may no be make upon a participant's "severance from employment". This will allow distributions from plans that terminate after a merger or spin off because participants will sever their employment relationship with the original employer. This effectively repeals the "same desk" rule.



Provisions Current Law New Law
Miscellaneous 457(b) Plan Changes The current "final three year catch up" limit is $15,000.
  • Taxation of QDRO distributions rules different that qualified plan QDRO distributions.
  • Distributions from 457(b) plans taxed when "made available" to employee.
  • More restrictive minimum distribution rules than qualified plans.

The "final three years" catch up provision is changed to the lesser of 100% of compensation or 200% of the normal limit.

  • The "final three year" provisions cannot be used if the new aged 50+ "catch up" provision is being used
  • QDRO distributions would be taxed the same as QDRO distributions from other qualified plans (taxable income to the recipient)
  • Rollover notice rules extended to governmental 457(b) plans
  • Distributions from governmental 457(b) plans would be taxed only when paid to the participant and reported on a form 1099R by the payer. Distributions from nongovernmental 457(b) plan would be taxed when "made available" and would continue to be reported as W-2 income by employer.
  • Special minimum distribution rules for 457 plans no longer apply. 457 plans would be subject to the normal 401(a)(9) required minimum distribution rules
Vesting Matching contributions must vest at least as rapidly as 100% after 5 years or incrementally over 7 years, at 20%/yr from years 3-7. Matching contributions must vest at least as rapidly as 100% after 3 years or 20% after 2 years and an additional 20% each year until 100% vested after 6 years.
Required Minimum Distributions Recent proposed regulations established new RMD rules Incorporates the recent RMD proposed regulations.
Hardship Withdrawal Safe Harbor Participants must not make elective deferrals into 403(b) or 401(k) plans for 12 months after taking hardship withdrawal from plan. The suspension period for elective deferrals after making a hardship withdrawal is reduced from 12 months to 6 months.
Tax Credit For New Plans of Small Business No Provision Certain small employers (fewer than 100) employees) would receive a tax credit for up to 3 years equal to 50% of the start up costs associated with establishing a new retirement plan.
Automatic Rollovers of certain Distributions No Provision If a plan requires a mandatory "cash out" of vested benefits of $5,000 or less, the plan may also require that such distributions be made into an IRA or other qualified retirement plan.

This provision is no effective until the DOL issues final regulations establishing "safe harbor" standards for default IRAs.




Provisions Current Law New Law
Tax credit for low income Savers No Provision

Nonrefundable tax credit for low/moderate income savers who make salary reduction contributions into 401(k), 403(b) or IRA plans. Credit is claimed on Form 1040 and applies to first $2,000 of contributions. The credit is based on following AGI schedule:

Credit        Individual             Joint Return
 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

If an eligible saver (or spouse) receives a pre-retirement distribution in any year, the credit will be reduces in the year and the next two years.

Loans for self employed persons Currently, self employed persons, sub-S shareholders and partners may no take loans from qualified plans. Such individuals would be permitted to take loans so long as loans were made available to all employees.
Deduction Issues Currently, there are many restrictions on deductibility of employer contributions based on a percentage of participant compensation and current funding liabilities. Employees' pre-tax contributions into 401(k) plans are not counted against the employer's contribution deduction limits.
  • Deduction for contributions into profit sharing and stock bonus plans increased from 15% of participants' compensation to 25%.
  • Compensation for purposes of determining deduction limit includes salary reduction contributions into 401(k) and 125 plans.
  • DB plan contributions are deductible up to the full amount of current liability.
  • DC contributions greater than 6% are disregarded when calculating  the excise tax for exceeding the deductible limit.
Elimination of Benefit Options Recent regulations permitted defined contribution plans to reduce benefit options without violating the "protected benefit" rules. The proposed regulations were included in the statute. The effect of this change is to permit most DC plans to offer only a lump sum distribution option.
Miscellaneous Administration Issues There are many complicated administrative issues applicable to discrimination testing, top heavy testing and combined 403(b)/401(k) plans. Top heavy rules are eased by simplifying the definition of "key employees".
  • Multiple use test for 401(k) plans with matching contributions is eliminated.
  • Controlled group employers with 403(b) and 401(k) plans may satisfy 410(b) coverage rules applicable to the 401(K) plan by disregarding 403(b) participants, subject to certain requirements.
Employer Provided Retirement Planning Services Currently unclear whether employer provided retirement planning services are a taxable fringe benefit. Clarifies conditions for offering retirements planning services on a tax-free basis.



Anticipated Impact of EGTRAA
1.   Larger contributions to all types of plans and opportunities for individuals to 
participate in more than one plan. For example, school teachers could make $11,000 
in elective deferrals into a 403(b) plan next year AND make another $11,000 
contribution into a 457(b) plan, for a total of $22,000 in contributions for 2002. If the 
teacher was over aged 50, then an additional $1,000 could be contributed into both 
plans using the new "catch up" provisions. 
2.   Easier 403(b) compliance because the need for calculations is greatly reduced. There 
is no MEA calculation and no percentage calculation for 415 purposes. The elective 
deferral limit is a fixed amount ($11,000 in 2002, $15,000 in 2006 and thereafter) and 
the 415(c) contribution limit applicable to employer and employee contributions is 
also a fixed amount of 100% of pay, not to exceed $40,000. The only time a 
calculation needs to be done is when determining if an employee with 15 years of 
service is eligible for the special $3,000/year catch up limit. 
(Remember, the 15 year 
catch up limit is only available if an employee has not contributed, on the average, at 
least $5,000/year into a 403(b) account. So, an averaging calculation must be done 
to ensure that the option is available.)
3.   Employer contributions into 403(b) plans will be easier because their MEA has been 
repealed and the 415(c) limitation is no longer a percentage based limit. 
4.   457 plans will become more important to public school employees and other 
nonprofit employers. Public school employees can double their elective deferral 
opportunities by adding a 457 program to their retirement planning. Because of 
ERISA issues, nongovernmental tax exempt organizations can offer 457 plans only to 
their top paid and management employees. However, this is usually the group of 
employees who are looking for additional opportunities to defer current taxation by 
increasing their retirement contributions. 
5.   Greater competition from into the 403(b) marketplace because elimination of the 
MEA removed one of the most significant market entry barriers. 
6.   Increased use of the Internet and no load competition because the technical 
requirements for participating in the 403(b) and 457 markets have been simplified. 
7.   More expertise will be needed to service clients. Clients will need help with 
portability issues and traditional vs. Roth decisions. Similarly, employees will need 
to know whether it would be better to buy past service credits or to let the assets grow 
in a 403(b) or 457(b) plans. To offer adequate service on these issues, 403(b) 
professionals will need to sharply increase their understanding of all other types of 
retirement plans, learn the breakpoints for current tax savings vs. later tax free 
withdrawals, and the benefits provided under the state pensions as compared to the 
future value of money invested in a tax deferred account. 
8.   Product pricing will change, as will compensation schedules, to accommodate 
portability. But the price advantages of no-loads will have a significant impact on the 
ultimate pricing structure. There will probably be more fee based revenue as 
professionals get paid for servicing clients, rather than making transactions for 
clients.

IMAGISOFT , Inc.  PO Box 13208  Albuquerque, NM 87192-3208   (877) 510-4702  support@imagisoft.com
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