Magazine article The CPA Journal

Qualified Retirement Plans and the 2001 Tax Act

Magazine article The CPA Journal

Qualified Retirement Plans and the 2001 Tax Act

Article excerpt


The 2001 Tax Act (Economic Growth and Tax Relief Reconciliation Act of 2001) makes extensive changes to qualified retirement plans, most of which take effect in 2002. Plan sponsors need to review the new provisions, which include increased contribution and benefits limits, 401(k) elective deferral limits, deductibility limits, and compensation limits. Many plan sponsors will want to take advantage of the increased qualified plan dollar and percentage limits to enlarge their retirement plan programs.

Contribution and Benefit Limits

The 2001 Tax Act contains a number of provisions regarding contribution and benefit limits for qualified plans. The 401(k) contribution dollar limit will increase from $10,500 to $15,000, beginning with a $500 increase in 2002. The limit increases $1,000 in each of the next four years, to $15,000 in 2006.

The defined contribution annual limit on additions will increase from $35,000 in 2001 to the lesser of $40,000 or 100% of compensation, effective in 2002. The annual dollar limit on additions (generally employer and employee contributions plus forfeitures) was $30,000 in 2000. Defined contribution plans include 401(k) and profit-sharing plans.

The defined benefit annual limit will increase from $140,000 to $160,000 for years ending after December 31, 2001, and the dollar limit need only be actuarially reduced for benefits commencing before age 62 (rather than the Social Security retirement age).

The maximum compensation for determining contributions and benefits under a retirement plan will increase from $170,000 to $200,000, effective in 2002.

"Catch-up" contributions may now be made by individuals age 50 and older in the amount of $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006. These amounts are additional contributions above the normal limits that apply to 401(k) plans, and are not subject to the special nondiscrimination test.

The limit on deductions for an employer's contributions to a stock bonus or profit-sharing plan increases from 15% to 25% after December 31, 2001.

Employee 401(k) elective deferrals will be deductible even where the employee participates in a stock bonus or profit-sharing plan, effective for tax years beginning after December 31, 2001.

For deduction purposes, compensation will no longer be reduced for employee elective deferrals made to a 401(k) plan or cafeteria plan, effective for tax years beginning after December 31, 2001.

IRA accounts under defined contribution plans will permit participants to make IRA contributions to a separate account maintained under a qualified plan, effective in 2003. IRA account contribution limits for deductible IRA contributions will increase to $3,000 per year in 2002-2004, $4,000 in 2005-2007, and $5,000 in 2008.

401 (k) Plans

The 2001 Tax Act included a number of changes directed specifically toward 401(k) plans. The multiple-use test applicable to 401(k) plans with matching employer contributions will be repealed effective in 2002. The same-desk rule will also be repealed and replaced with a "sever-ance from employment" standard, effective in 2002.

The hardship distribution IRS safe harbor will now require only a six-month suspension of participation (rather than a 12month suspension).

Matching contribution accounts under non-top-heavy plans will be required to vest under a top-heavy vesting schedule (i.e., three-year cliff or six-year graded), effective for plan years beginning after December 31, 2001.

Participant loans from qualified plans will be permitted for owner-employees (S corporation shareholders, partners, LLC members, and sole proprietors), effective in 2002.

Effective in 2006, Roth IRAs under 401(k) plans may permit participants to elect a tax treatment providing for after-tax contributions and tax-free distributions. …

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