Big Changes, Big Benefits: Making Sense of the New Pension Reform Laws

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EXECUTIVE SUMMARY

* THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION Act made significant changes to pension and retirement planning. Maximum contributions to 401(k) plans jumped to $11,000 for 2002 and will increase $1,000 per year until 2006. Similar increases apply to 403(b) and 457 plans as well as SAR-SEPs. IRA contributions--both regular and Roth--increased to $3,000 and will rise to $5,000 by 2008.

* RETIREMENT PLANS ACROSS THE BOARD NOW ARE MORE portable. Investors can roll over most types of employer-sponsored plans into another plan or an IRA or roll over an IRA into an employer-sponsored qualified plan--if the plan permits such a move. Reliever extensions also now will be available under certain circumstances.

* COMPANIES NOW CAN CONTRIBUTE UP TO 25% of payroll to profit sharing, up from 15%. Retirement benefits for highly compensated employees in defined benefit plans increase to $160,000 payable as early as age 62, and will be indexed for inflation. 401(k) providers now are required to vest matching contributions faster, using one of two methods.

* CONGRESS MODIFIED THE TOP-HEAVY RULES THAT WEE onerous for many small companies. The act modifies the definition of key employee, narrowing the number of workers who will fall under it. Unless an executive owns 5% of the business, he or she now has to make at least $130,000 to be considered a key employee.

* BEGINNING THIS YEAR, EMPLOYEES WHO ARE 50 YEARS or older can make an additional $1,000 contribution to their 401(k), 403(b), SAR-SEP or 457 plan. This amount increases to $5,000 by 2006. These same workers will be able to contribute $500 extra to an IRA in 2002 as well, with another $500 increase in 2005.

CPAs who help clients with pension planning, take notice: Sweeping changes in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) have transformed this discipline. Fortunately, most of the changes are beneficial. For instance, 401(k) participants now can contribute more money and plan participants can move money more freely between plans. Future benefits and contributions will be calculated more liberally. In addition, to encourage small businesses to offer retirement plans, increased benefits now are available to the company's principals and officers.

Nonetheless, despite the overall positive nature of the changes, the act still poses some pitfalls for the unwary. Many business and individual clients may need to adopt different strategies to get the most benefit from the new regulations and avoid the traps. (Of course, any pension planning CPAs do is complicated by the fact that, at least in theory, all of EGTRRA's provisions will sunset in 2011. But in the meantime, due diligence requires amending and rewording client plans.) This article outlines some of EGTRRA's key pension reforms. Although much of the law is easy to understand, with clear dictates for best practice, the author has included "CPA alerts" when extra care is required.

GOOD NEWS FOR THE RANK AND FILE

EGTRRA's provisions give employees across the board more opportunities to save. Here are some of the important changes that can help to add more cash to the retirement pot.

Increased elective pension deferrals. Employees now can salt away more cash. Pretax contributions to 401(k) plans, previously limited to $10,500 annually, increased to $11,000 for 2002 and will increase $1,000 per year until 2006, when they reach $15,000--an increase of more than 40%. For the next five years until (or if) the act sunsets, the contribution ceiling will be indexed for inflation in $500 increments.

Similar increases apply to 403(b) plans offered to teachers and employees of nonprofits; 457 plans, found mostly in state and local governments; and SAR-SEPs, a salary-reduction type of Simplified Employee Pension.

IRA increases. Both regular and Roth IRAs now also have larger contribution limits. …