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Running Retirement Plans May Be Simpler

By Martha Priddy Patterson

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The new Economic Growth and Tax Relief Reconciliation Act of 2001 makes some of the first significant efforts to simplify retirement savings plan administration in years.

EGTRRA has helped employers and their benefits advisors by strengthening the foundations of the entire retirement savings system, by increasing and eliminating many retirement savings limits.

EGTRRA has increased the maximum covered compensation to $200,000, from $170,000.

A few of the many other major changes include an increase in the limit on annual contributions to defined contribution plans to $40,000, from $35,000; elimination of a provision that capped contributions at 25% of compensation; and an increase in maximum annual benefits from defined benefit plans to $160,000, from $140,000.

But EGTRRA has also made many improvements in plan administrative requirementsthe wiring and floor plan for the retirement savings structure.

Sponsors can now eliminate payment and benefit options.

Generally the tax and ERISA vesting rules prohibit any reduction in a participants accrued benefit under a qualified plan.

Among other things, this “anti-cutback” rule protects optional forms of distributions or payments.

But, with plan mergers and design changes, a plan eventually can accumulate dozens of confusing and difficult-to-communicate distribution options, many of which participants never use.

The new law allows defined contribution plans to simplify their payment and benefit options by eliminating a form of distribution, as long as the receiving plan offers a lump-sum payment option available at the same time as, and based on the same or greater portion of the participants account as, the form of distribution being eliminated.

EGTRRA also requires new regulations permitting plan amendments that eliminate or reduce early-retirement benefits, retirement-type subsidies and optional forms of benefit that create significant burdens or complexities for the plan and plan participants, unless the amendment adversely affects the rights of any participant in a more than de minimis manner.

The rules for identifying “top heavy” plans are simpler.

The EGTRRA changes to the so-called “top-heavy” plan criteriaplans in which more than 60% of the contributions or benefits under the plan are provided to “key” employeeswill simplify administration of existing plans, eliminating many “look-back” rules and the need to keep detailed records of key-employee status.

These changes may also significantly reduce the number of top-heavy plans.

Consequently, these changes can expand the market for retirement plans, especially among medium and small employers that previously shunned retirement plans because of the top-heavy rules.

To meet the requirements for tax-qualified plans, top-heavy plans usually must provide faster vesting and enhanced benefits or contributions for non-key employees.

The definition of “key employee,” coupled with a four-year look-back to establish key employee status, made these plans extremely difficult and expensive to administer.

Under the old law, a key employee typically was one who was: in the current or past four years an officer earning more than $70,000 a year; a 5% owner; a 1% owner earning more than $150,000 a year; or one of the employees with the 10 largest ownership interests in the employer, and earning more than $35,000 a year.

Beginning with 2002 plan years, EGTRRA narrows the basic criterion used to determine top-heavy status: the definition of “key employee.”

The new definition includes only an individual in the current year who is an officer earning more than $130,000 for the year (adjusted for inflation), a 5% owner, or a 1% owner earning over $150,000 (not adjusted for inflation). For this purpose, the number of officers will never exceed 50 individuals.

Next, the top-heavy plan test will include both current year distributions and in-service distributions over the last five years in calculating an individuals benefits or accounts.

The accrued benefit or account balance of an individual who did not work during the year is excluded from the top-heavy calculations.

In determining the minimum benefit required under a defined-benefit plan, a year of service will not include any year in which no key employee or former key employee accrued benefits under the plan, thereby eliminating benefit funding requirements for frozen plans.

A 401(k) plan that satisfies the design-based safe harbor for elective deferrals and matching contributions (in other words, generally contributes at least 3% of compensation, or offers 100% matching contributions for the first 3% of compensation deferred and a 50% match on the next 2% of deferred compensation) is not a top-heavy plan.

Employer matching contributions can be counted in satisfying the top-heavy minimum benefit requirement.

The 401(k) multiple-use test and same-desk rule are gone.

EGTRRA repeals the 401(k) plan administrators twin nightmares: the so-called “multiple-use test,” which prohibits using a more favorable nondiscrimination test for both deferrals and contributions; and the “same-desk rule,” which prohibits distributionsincluding rolloversof 401(k) plan accounts when employees are transferred to a new business owner.

These two rules caused countless administrative problems, greatly increasing the cost of plan administration and angering plan participants.

The multiple-use test involved the special 401(k) nondiscrimination rules, limiting elective deferrals and employer-matching contributions for highly compensated employees.

The multiple-use test provides that sponsors can pass the actual deferral percentage and the actual contribution percentage tests in one of two ways:

(1) The actual deferral percentage or actual contribution percentage for the highly compensated employees is no more than 125% of the comparable percentages for the non-highly compensated employees; or

(2) The ADP or ACP of the highly compensated employees is no more than 200% of the comparable percentages for the non-highly compensated employees, and no more than 2 percentage points greater than the comparable percentages for the non-highly compensated employees.

Under the old law, a 401(k) plan could not use the more generous 2 percentage point/200% limit to satisfy both tests.

Under the new law, effective for 2002 plan years, the Internal Revenue Service must stop enforcing the multiple-use rule.

EGTRRA asks the IRS to draft new regulations regarding 401(k) nondiscrimination testing.

Of course, the actual degree of simplification this change offers will depend on the complexity of the new regulations, which presumably will be less complicated than the old multiple-use test.

The other nightmare rule, the IRS same-desk rule for 401(k) plans, comes into play when an employee continues on the same job for a different employer as a result of a sale, liquidation, spin-off or other similar corporate transaction. In such cases “no separation from service” occurs that would permit a distribution of the employees 401(k) account balance.

Unless the employee died, became disabled, reached age 59-and-one-half or went through some other event that allowed a distribution, the account held with the former employer could not be transferred to the new employer.

EGTRRA repeals the “same-desk” rule by amending the condition-for-distribution standard to be “severance from employment,” rather than separation from service.

EGTRRA emphasizes that Congress intends that sales, spin-offs and the like be considered “severance from employment.”

is national director of employee benefits policy in the Washington office of Deloitte & Touche Human Capital Advisory Services. Her e-mail address is [email protected]

Reproduced from National Underwriter Life & Health/Financial Services Edition, October 8, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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