Pension Reform: The Economic Growth and Tax Relief Reconciliation Act of 2001
CRS Report for Congress
Pension Reform: The Economic Growth and
Tax Relief Reconciliation Act of 2001
Patrick Purcell
Specialist in Social Legislation
Domestic Social Policy Division
Summary
On June 7, 2001 the President signed into law the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA, P.L. 107-16). Title VI of this law deals with
pension plans and retirement savings accounts. P.L. 107-16 increases the maximum
annual contribution to an individual retirement account (IRA) from $2,000 per
individual to $5,000. It also increases the annual contribution limits on §401(k) plans,
§403(b) annuities, and §457 deferred compensation plans for employees of state and
local governments. Other measures are intended to encourage employers to offer
pensions, increase participation by eligible employees, raise limits on benefits, improve
asset portability, strengthen legal protections for plan participants, and reduce regulatory
burdens on plan sponsors. The provisions of the law that reduce federal tax revenue are
scheduled to sunset after 10 years.
Individual Retirement Accounts. Prior to enactment of EGTRRA, the annual
contribution limit for individual retirement accounts (IRAs) had not been changed since
Congress set the limit at $2,000 in 1981. EGTRRA increases the annual limit on IRA
contributions according to the following schedule:
Maximum
Year Contribution
2002$3,000
2003$3,000
2004$3,000
2005$4,000
2006$4,000
2007$4,000
Congressional Research Service ˜ The Library of Congress
In calendar years after 2008, the limit will be indexed to the Consumer Price Index
in $500 increments. For individuals age 50 and older, the maximum allowable
contribution to an IRA will increase by an additional $500 in 2002 through 2005 and by
$1,000 in each year thereafter.
EGTRRA allows employers who maintain separate retirement savings accounts for
their employees in addition to a tax-qualified retirement plan to designate those separate
accounts as individual retirement accounts, provided that the accounts meet the
requirements applicable to either traditional IRAs or Roth IRAs. These “deemed IRAs”
will be subject to fewer reporting rules than tax-qualified employer-sponsored plans.
Benefit and Contribution Limits on Employer-sponsored Pensions and
Retirement Savings Plans. Beginning in 2002, the maximum annual benefit payable
by a tax-qualified defined benefit pension was increased from $140,000 to $160,000.
Thereafter, it is indexed to inflation in $5,000 increments. The annual limit on benefits
is reduced if benefits begin before age 62 and increases if benefits begin after age 65. A
special rule applies to airline pilots if they are required to retire before age 62. The limit
on compensation that may be taken into account under a plan was increased from
$170,000 in 2001 to $200,000 in 2002. It is indexed in $5,000 increments. The limit on
annual additions to defined contribution plans – comprising the sum of employer and
employee contributions – was increased from $35,000 in 2001 to $40,000 in 2002, and
it is indexed in $1,000 increments.
In 2001, the limit on annual elective deferrals under Section 401(k) plans, Section
indexed to inflation in $500 increments. EGTRRA increased this limit to $11,000 in
2002 and by $1,000 each year thereafter until it reaches $15,000 in 2006. In years after
Beginning in 2006, a Section 401(k) plan or a Section 403(b) annuity will be permitted
to allow participants to elect to have all or a portion of their elective deferrals under the
plan treated as after-tax contributions, called “designated Roth contributions.” These
contributions will be included in current income, but qualified distributions from
designated Roth contributions will not be included in the participant’s gross income.
Such contributions will otherwise generally be treated the same as elective deferrals for
purposes of the qualified plan rules.
The maximum deferral under a Section 457 plan for employees of state and local
governments was $8,500 in 2001. EGTRRA raised this limit to $11,000 in 2002,
$12,000 in 2003, $13,000 in 2004, $14,000 in 2005, and $15,000 in 2006. The limit will
be indexed in $500 increments thereafter. For the 3 years immediately preceding
retirement, the limit on deferrals under a Section 457 plan will be twice the otherwise
applicable dollar limit. The law also repealed the rules coordinating the dollar limit on
Section 457 plans with contributions under other types of plans. The maximum annual
elective deferral to a savings incentive match plan for employees of small employers
(SIMPLE) was $6,000 in 2001. EGTRRA increased this limit to $7,000 in 2002 and by
$1,000 annual increments thereafter until it reaches $10,000 in 2005. The $10,000 dollar
limit will be indexed to inflation in $500 increments.
The law also:
!eases some restrictions that apply to loans made by a qualified plan to an
owner-employee;
!simplifies the definition of a “key employee” and the determination of
a plan that is “top-heavy” with respect to benefits for key employees;
!provides that a Section 401(k) plan that meets the “safe-harbor”
requirements for minimum contributions on behalf of its participants is
not a “top-heavy plan” (i.e., it does not discriminate in favor of highly
compensated employees);
!allows matching contributions to be taken into account in satisfying the
minimum contribution requirements;
!provides that employees’ elective salary deferrals under a qualified plan
will not be counted as employer contributions for purposes of the
maximum allowable employer deduction for retirement plan expenses;
!increases the limit on deductible contributions under a profit-sharing or
stock bonus plan from 15% to 25% of the compensation of the employees
covered by the plan;
!provides a nonrefundable tax credit of up to $1,000 for contributions to
a qualified retirement plan by individuals with adjusted gross income less
than $25,000 and couples with adjusted gross income under $50,000;
!provides small employers with a tax credit of up to 50% of the cost
starting a retirement plan, up to a maximum credit of $500, and
!eliminates certain user fees levied by the IRS for determination letters
requested during the first 5 plan years with respect to the qualified status
of an employer-sponsored retirement plan.
Enhancing Fairness for Women.1 EGTRRA permits individuals who are age
50 or older to make additional contributions to a retirement plan authorized under section
401(k), 403(b), or 457 of the tax code. The maximum permitted additional contribution
is $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006. This amount will
be indexed to inflation in years after 2006. Catch-up contributions to a Section 401(k)
plan or similar plan will not be subject to any other contribution limits and will not be
taken into account in applying other contribution limits; however, they will be subject to
the nondiscrimination rules.
The law increases the limit on annual additions (the sum of employee and employer
contributions) under a defined contribution plan from 25% of compensation to 100%, and
conforms the limits on contributions to a tax-sheltered annuity to the limits applicable to
tax-qualified plans. It also increases the limitation on deferrals under a Section 457 plan
from 33.3% of compensation to 100% of compensation.
Employees are always fully vested in their own contributions to a defined
contribution plan, and they must be fully vested in employer matching contributions to
such plans in no more than 5 years if the employer uses “cliff” vesting and in no more
than 7 years if the employer uses “graded” vesting. EGTRRA accelerates these schedules
1 These provisions are designed to help workers with brief or intermittent work histories.
so that employees will be fully vested in employer matching contributions in a maximum
of 3 years under cliff vesting and in no more than 6 years under graded vesting.
The law directed the Secretary of the Treasury to update the life expectancy tables
on which required minimum distributions are based. As directed, Treasury published the
new tables in 2002. The law provides that distributions from a Section 457 plan made
pursuant to a qualified domestic relations order (QDRO) are to be made under the same
tax rules that apply to distributions from tax-qualified plans as the result of a QDRO. In
addition, a Section 457 plan that makes payments to an alternate payee is not to be treated
as violating the restrictions on distributions from such plans if such payments were made
under a QDRO. The law also repeals the special minimum distribution rules that
previously applied to Section 457 plans and makes these plans subject to the minimum
distribution rules applicable to §401(k) plans.
Previously, employees were prohibited from making employee contributions and
elective contributions for 12 months after pre-retirement “hardship” distributions made
to satisfy immediate financial needs. EGTRRA reduces this period to 6 months.
Hardship distributions are not to be treated as eligible rollover distributions.
Increasing Portability for Participants. The law allows eligible distributions
from tax-qualified pension plans, §401(k) plans, § 403(b) annuities, IRAs, and §457
deferred compensation plans to be rolled over into any other such plan or arrangement.
The rules for tax withholding applicable to rollovers from qualified plans have been
extended to distributions from §457 plans. Employee after-tax contributions can now be
rolled over into another qualified plan or a traditional IRA. In the case of a rollover from
a qualified plan to another qualified plan, the rollover is permitted only through a direct
rollover. Surviving spouses may roll over distributions to a qualified plan, §403(b)
annuity, or §457 plan in which the spouse participates. The law allows the Secretary of
the Treasury to waive the 60-day rollover period if the failure to waive such requirement
would be against equity or good conscience.
Provided that certain requirements are satisfied, a defined contribution plan to which
benefits are transferred will not be treated as reducing a participant’s accrued benefit if
it does not provide all of the forms of distribution that previously were available to the
participant. In addition, the Secretary has been directed to specify the circumstances
under which early retirement benefits, subsidies, or optional forms of benefit may be
reduced or eliminated without the rights of participants being materially affected.
Previously, distributions from §401(k) plans, §403(b) annuities, and §457 plans
generally could occur without penalty only upon separation from service under the
particular plan. Separation from service occurs only with the participant’s death,
retirement, resignation, or discharge. EGTRRA modifies the distribution restrictions to
provide that a distribution may occur upon severance from employment with the plan
sponsor, including a separation that occur as the result of a merger or acquisition. This
effectively has repealed the so-called “same-desk rule,” which prohibited pre-retirement
distributions to employees whose employer merges with or is acquired by another firm
if the employee continues to work at the same job.
EGTRRA provides that a participant in a state or local governmental plan is not
required to include in gross income a direct trustee-to-trustee transfer to a governmental
defined benefit plan from a §403(b) annuity or a §457 plan if the transferred amount is
used to purchase permissive service credits under the plan or to repay certain
contributions.
Under current law, a lump-sum distribution of accrued retirement benefits can be
paid to a departing employee without the employee’s consent, provided that the present
value of the accrued benefit does not exceed $5,000. The participant’s written consent
is required for such distributions if the value of the distribution exceeds this amount.
EGTRRA allows a plan sponsor to disregard benefits attributable to rollover contributions
for purposes determining whether a lump-sum distribution will be greater than $5,000.
In the case of involuntary distributions of $1,000 or more, the law makes direct rollover
to an IRA the required method of distribution unless the participant directs otherwise.
Strengthening Pension Security and Enforcement. Under prior law, the
“full funding limit” for tax-qualified plans was 150% of the plan’s accrued liability.
EGTRRA raised this limit to 165% of current liability for plan years beginning in 2002
and to 170% for plan years beginning in 2003. The current-liability full-funding limit has
been repealed for plan years beginning in 2004 and thereafter. The special rule allowing
a deduction for unfunded current liability generally has been extended to all defined
benefit pension plans covered by the Pension Benefit Guaranty Corporation (PBGC). In
determining the amount of pension contributions that are not deductible, an employer is
permitted to disregard contributions to a defined benefit plan except to the extent that they
exceed the accrued-liability full-funding limit. If an employer so elects, contributions in
excess of the current-liability full-funding limit are not subject to the excise tax on
nondeductible contributions.
Because pension benefits under multi-employer plans are generally based on factors
other than compensation – such as a flat benefit per month of service – the limits on
benefits provided for under §415 of the tax code can result in significant benefit
reductions for workers who are covered by these plans and whose compensation varies
from year to year. EGTRRA eliminates the cap on benefits (equal to 100% of
compensation) for multi-employer plans and provides that multi-employer plans are not
to be aggregated with single employer plans for purposes of applying the 100%-of-
compensation cap to those plans. The law also clarifies the method of determining the
tax year to which an employer contribution to a multi-employer plan is attributable.
Section 1534(b) of the Taxpayer Relief Act of 1997 (P.L. 105-34) prohibits the
sponsor of a §401(k) plans from requiring part of an employee’s elective deferrals to be
invested in the employer’s securities or property. EGTRRA clarifies that §1534(b) does
not apply if these assets were acquired as the result of deferrals made before 1999. The
law also requires an excise tax to be levied on an employee stock ownership plan (ESOP)
engaging in prohibited transactions with “disqualified individuals” deemed to be
substantial shareholders of the corporation sponsoring the plan.
EGTRRA requires the sponsors of defined benefit plans to notify plan participants
in advance of any amendment that would significantly reduce the rate of future benefit
accruals. (Such reductions in accrual rates sometimes occur, for example, when a
traditional pension is converted to a cash balance plan). A plan amendment that reduces
or eliminates an early retirement benefit or retirement-type subsidy will be considered as
reducing the rate of benefit accrual. The notice must include sufficient information to
allow participants to understand the effect of the amendment. An excise tax will be levied
against the plan sponsor if the required notice is not provided. The Secretary of the
Treasury is authorized to allow simplified forms of notification, or to exempt from the
notification requirement, plans with fewer than 100 participants and plans that allow
participants to choose between the old and new plan benefit formulas. The Secretary is
required to report to Congress on the effect of cash balance conversions on participants’
pension benefits, with special reference to periods during which no new benefits are
accrued (so-called “wear-away” periods).
Reducing Regulatory Burdens. A defined benefit plan with assets equal to at
least 125% of current liability is permitted to use a valuation date within the prior plan
year. An employer is entitled to deduct dividends that, at the election of plan participants
or their beneficiaries, are paid to the plan and reinvested in employer securities. The
special definition of a “highly compensated employee” under the Tax Reform Act of 1986
has been repealed.
The law directs the Treasury Department to revise its regulations under §410(b) to
provide that, if certain requirements are satisfied, employees of a tax-exempt charitable
organization who are eligible to make salary reduction contributions under a §403(b)
annuity may be excluded for purposes of testing a §401(k) plan for nondiscrimination in
favor of highly compensated employees. Qualified retirement planning services provided
to an employee and his or her spouse by an employer maintaining a qualified plan
generally can be excluded from employee income.
Under prior law, elective deferrals under a §401(k) plan were tested for
discrimination in favor of highly compensated employees by means of the actual deferral
percentage test (“ADP test”) and the actual contribution percentage test (“ACP test”).
Under certain circumstances, the Treasury Department could subject a plan’s elective
deferrals, employer matching contributions, and after-tax employee contributions to an
additional nondiscrimination test, called the “multiple use test.” EGTRRA repeals the
multiple use test.
Tax treatment of electing Alaska Native Settlement Trusts. In order to
encourage Alaska Native Settlement Corporations to establish Settlement Trusts, the law
allows an election under which special rules will apply in determining the income tax
treatment of a Trust and its beneficiaries.