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On June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16, the "Act"), implementing the most significant changes to the tax laws affecting retirement plans in the past 15 years. Employees will benefit from opportunities for increased savings and greater portability between different retirement vehicles. Employers will have greater flexibility in designing plans, but they will be subject to new requirements, such as increased disclosure obligations for amendments that reduce future pension benefits and new notice requirements on distribution options.

Most of the provisions take effect January 1, 2002, although some changes are delayed until later years. All of the provisions are set to expire on December 31, 2010, absent further Congressional action.

Highlighted below are provisions of the Act that will affect employee benefit plans offered by private sector employers and governmental and tax-exempt organizations, as well as individual retirement accounts (IRAs).

Defined Contribution Plans: Higher Limits, Faster Vesting and Greater Portability

• Maximum annual elective deferral contributions to a 401(k) plan increases to $11,000 in 2002, increasing in $1,000 annual increments to $15,000 by 2006 (then indexed for inflation in $500 increments in later years).

• Maximum annual allocations (including both employer and employee contributions) increase to the lesser of $40,000 or 100% of compensation (indexed for inflation in $1,000 increments).

• The compensation limit for purposes of determining plan contributions and benefits increases to $200,000 (indexed for inflation in $5,000 increments).

• 401(k) plans may permit participants over the age of 50 to make additional "catch-up" contributions of $1,000 in 2002, increasing to $5,000 by 2006. If this option is offered to any group of employees, it must be offered to all eligible employees under all 401(k) plans maintained by the same or an affiliated employer.

• Employer matching contributions must vest at least as fast as 100% after three years of service, or 20% after two years of service and 20% per year thereafter, with 100% vesting after six years of service.

• Participants in 401(k) plans, governmental 457 plans, and 403(b) annuities can roll over distribution amounts between plans or to an IRA. After- tax contributions may also be rolled over to an IRA or to another qualified plan that can properly account for such contributions. This will require changes in notices provided to participants when distributions are made from these plans.

• Employees who continue in the same job for a successor employer after a sale of the business may receive distributions from 401(k) plans. The "same desk" rule that formerly prohibited a distribution in this situation has been repealed and there is now deemed to be a "severance from employment" that permits a distribution unless all or a portion of the 401(k) plan is assumed by the successor employer.

• The Act makes it easier for sponsors of defined contribution plans to remove unwanted forms of benefit payments without violating "anti-cutback" rules.

• The annual limit on an employer's tax deduction for contributions to a qualified defined contribution plan is increased to 25% of the aggregate compensation of plan participants. In addition, elective deferrals are now deductible without limit.

• Beginning in 2003, employers may permit employees to have "deemed IRAs" under a qualified defined contribution plan. This will allow employees to contribute money under a plan outside of 401(k) limits, but subject to IRA limits. Similarly, beginning in 2006, employers may permit employees to designate elective deferrals as Roth IRA contributions, which would be taxed at the time of deferral but not at distribution.

• After the U.S. Department of Labor issues appropriate regulations (within three years after the enactment of the Act), plans must provide that any mandatory cash-out distribution exceeding $1,000 be rolled over into an IRA.

• Hardship withdrawals from defined contribution plans (including hardship withdrawals of employer matching contributions as well as elective deferral amounts) will not be eligible for rollover. In addition, under the "safe harbor" rules for hardship withdrawals from 401(k) plans, the period after a hardship withdrawal during which employee contributions are prohibited is reduced to six months.

• The "multiple use" test affecting highly compensated participants in 401(k) plans has been repealed.

Defined Benefit Plans: Higher Limits and Increased Disclosure

• As is the case for qualified defined contribution plans, the compensation limit for purposes of determining qualified defined benefit plan benefits is increased to $200,000 (indexed for inflation in $5,000 increments).

• For limitation years ending after December 31, 2001, the maximum annual benefit payable from a qualified defined benefit plan is increased to $160,000 (indexed for inflation in $5,000 increments). Note that for defined benefit plans with non-calendar limitation years, the increased dollar limit is effective immediately. This limit is reduced if benefit payments begin before age 62, and increased if payments begin after age 65. As under prior law, the annual benefit can never exceed 100% of the participant's average compensation for his or her highest three years.

• Tax deduction limits on funding are significantly relaxed. The current liability full funding limit is increased to 165% of current liability in 2002, 170% in 2003, and repealed entirely in 2004. Contributions made to fully fund terminating plans will be fully deductible.

• Effective immediately, increased disclosure to participants is required in the event of a significant reduction in future benefit accruals in a defined benefit or money purchase pension plan, including the elimination or significant reduction of early retirement benefits or similar subsidies. This notice must include sufficient information to describe to participants the effect of the amendment. The notice must be given within a reasonable time before the reduction takes effect, and may be sent prior to adoption of the amendment modifying the benefit so long as no material changes are made after the notice is given. Violations are subject to a penalty of $100 per day per participant. Egregious violations could invalidate the desired reduction in benefits.

Tax Exempt Organizations and Governmental Plan Sponsors: New Planning Opportunities

• P.L. 107-16, Table of Contents and Title VI (Pension and Individual Retirement Arrangement Provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001) [204K]

• H.Rpt. 107-84, pp. 115-120, 205-306 (Joint Explanatory Statement of the Committee of Conference, Table of Contents and Title VI, Pension and Individual Retirement Arrangement Provisions) [327K]

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