EGTRRA:
NEW RULES AFFECTING GOVERNMENT RETIREMENT PLANS
Prepared By: Patricia K.
Keesler
Benefits Law Group
Atlanta, Georgia
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was signed into law on June 7, 2001, and affects the administration and operation of retirement plans sponsored by government employers. The new law provides enhancements, simplifications and incentives to foster retirement programs. Some of the more significant provisions are highlighted below
I. INCREASE IN COMPENSATION LIMIT
Prior Law: $150,000 limit in 1994 (1996 for government plans), indexed to $170,000 in 2001.
EGTRRA Change: $200,000, indexed for inflation rounded down in $5,000 increments.
Practical Effect: 11% increase in recognized compensation in 2002.
Question: Will the increased limit apply retroactively under defined benefit plans?
Prior Law: After-tax dollars are required to be used to purchase or repurchase service credit under a defined benefit plan.
EGTRRA Change: Participants who are permitted to purchase service credit under the plan may use amounts accumulated in a 457 plan to pay for that service in a direct transfer from the 457 plan to the defined benefit plan.
Practical Effect: Many employees who could not afford to purchase service credit will now be able to do so. This transfer does not cause a taxable distribution from the plan.
Question: Financial impact on the defined benefit plan.
Prior Law: Contributions are limited to the lesser of $8500 (in 2001) or 33 1/3% of compensation under 457 plans. In the 3 years before retirement, the limit increases to $15,000.
EGTRRA Change: Contributions to 457 plans will be limited to $11,000 in 2002 up to $15,000 in 2006 ($1,000 per year) and then indexed for inflation. The percentage limitation is increased to 100% of compensation.
Practical Effect: Deferral limit is the same as in private 401(k) plans. A part time employee who is covered by a plan will be able to defer up to 100% of compensation (up to the dollar limit).
Prior Law: Participants in 457 plans must offset deferrals made to a 403(b) plan or 401(k) plan.
EGTRAA Change: 457 contributions will not have to be offset by deferrals made to a 403(b) plan or 401(k) plan.
Practical Effect: Individuals who participate in a 457 plan
and a 403(b) or 401(k) plan can defer up to $22,000 in 2002 and $30,000 in 2006.
Prior Law: No catch up provisions under qualified plans. Catch up deferrals are permitted in 457 and 403(b) plans.
EGTRRA Change: Employees who have attained age 50 may make catch up contributions beginning in 2002 - $1,000 in 2002 up to $5,000 in 2006, increasing $1,000 per year. Catch up deferrals are not subject to other plan limitations. Apparently, this can apply to defined benefit plans, also.
Practical Effect: Increase in retirement benefits. Cannot use this catch-up provision in the same years as the current $15,000 catch-up.
Question: How will these provisions be administered and coordinated with the current “catch up” provisions in 457 plans?
Prior Law: Amounts held under 457 plans and 403(b) plans cannot be commingled with amounts in 401(k) plans, or other qualified plans or placed in an IRA. The 60-day rollover period is strictly enforced.
EGTRRA Change: Employees will now be able to roll over certain amounts to and from 457 plans, 403(b) plans, IRAs and qualified plans. After-tax amounts can be rolled in to IRAs and qualified plans but not from an IRA into a non-IRA. The IRS can waive the 60-day rollover period where delay was outside the control of the taxpayer.
Practical Effect: Greater portability between plans. Employees with 457 plans will be able to consolidate all retirement savings into one plan. Rollover notices will need to be revised. Default form of distribution where there is a mandatory cashout provision is now to an IRA.
Question: The 10% early withdrawal penalty does not apply to 457 amounts. Will plan and IRA sponsors be able to keep those funds separate to avoid the penalty on the 457 amounts?
Prior Law: Annual benefits are limited to $90,000 under a defined benefit plan and annual contributions are limited to 25% of compensation or $35,000 (for 2001) in a defined contribution plan.
EGTRRA Change: The defined benefit plan dollar limit on benefits will increase to $160,000 and the defined contribution limit will increase to the littlest of 100% of compensation or $40,000.
Practical Effect: Substantial increase in some pensions and substantial increase in contributions permitted into defined contribution plans.
Prior Law: 457 amounts are subject to income tax when amounts held under the plan are made available (“constructive receipt”) or paid. Participant can choose to delay distribution without current tax using a one time irrevocable election. Taxable amounts are reported on Form W-2 and subject to income tax withholding.
EGTRRA Change: The constructive receipt rule is repealed for 457 plans. Distributions from 457 plans after 2001 will be taxed like distributions from qualified plans, subject to pension withholding and reported on a Form 1099.
Practical Effect: 457 plans look more like 401(k) plans.
Prior Law: Distributions to the divorced spouse of a participant are not permitted under a 457 plan, even under a divorce decree.
EGTRRA Change: A 457 plan may recognize qualified domestic relations orders (QDROS) like private sector qualified plans.
Prior Law: Employer paid costs associated with providing employees with retirement planning advice is taxable compensation to the employee.
EGTRRA Change: There is a specific exclusion from income for employer paid qualified retirement planning advice, so long as it is not limited to highly compensated employees.
Prior Law: Elective deferrals and IRA contributions are not included in income. There is no other tax credit or deduction.
EGTRRA: For tax years 2002-2006, a nonrefundable tax credit of up to $1000 is available to employees who contribute to an IRA, 403(b), 457 or qualified plan. The amount depends on tax status and adjusted gross income. The credit applies to the first $2000 of contribution and ranges from 10-50% of the contribution made.
50%: up to $30,000 joint filers / $15,000 single taxpayers
20%: $30,001-$32,500 joint filers / $15,001-$16,250 single taxpayers
10%: $32,501-$50,000 joint filers / $16,251-$25,000 single taxpayers
0%: over $50,000 joint filers/ over $25,000 single taxpayers
Any distribution made within 2 years will offset the amount of the credit.
Practical Effect: Since this is a credit it applies to directly reduce tax liability. However, it applies to taxpayers with the lowest tax liability, Therefore, if someone has no tax liability, the credit is of little use.