T Reconciliation Act of 2001 (the Act) ushers many of the Acts - PDF document

G Employee Benefits Alert August 2001 The Economic Growth and Tax Relief Reconciliation Act of 2001 he Economic Growth and Tax Relief This Alert and the enclosed table summarize T Reconciliation Act of 2001 (the “Act”) ushers many of the Act’s employee benefits changes and in the most significant changes to employee highlight our observations and recommendations for benefit plans in 15 years. Although some changes are employers to consider in adapting their benefits phased in over a period of years, many are effective programs to the Act. January 1, 2002. As a result, employers will need to take swift action to determine how the Act will affect Increases in Benefit and Contribution Limitations their employee benefit plans. The Act significantly increases many benefit Every employer, large and small, that maintains a limitations applicable to tax-qualified plans. The tax-qualified pension, profit sharing or 401(k) plan following are highlights: can expect to be affected by the Act. The Act • The 401(k) contribution limit will increase to significantly raises many benefit and contribution limitations and includes helpful administrative $11,000 effective January 1, 2002, and will provisions. While some provisions of the Act are continue to increase each year thereafter by $1,000 phased in over a period of years, many benefits until the limit reaches $15,000 in 2006. changes are either fully effective, or begin to be • Aggregate “annual additions” to defined effective, for plan years beginning after December 31, contribution plans will increase from $35,000 to 2001. Accordingly, employers must take steps to $40,000 effective for the first plan year beginning review the Act’s effects on their benefit plans as soon after December 31, 2001. as possible. • The deductible limit on contributions to a profit The Act does not extend the deadline for employers to amend their plans to comply with the sharing plan will increase from 15% to 25% of requirements of “GUST,” an acronym for a series of compensation effective for plan years beginning tax law changes enacted between 1994 and 1998. after December 31, 2001. Thus, employers still must amend their plans to • The annual benefit payable under a defined benefit reflect the GUST changes by the last day of the pension plan is increased from $140,000 to “GUST remedial amendment period,” that is, by the $160,000 effective for plan years beginning after last day of the first plan year beginning on or after December 31, 2001, and is unreduced for benefits January 1, 2001 (December 31, 2001, for calendar commencing at the age of 62. year plans). In addition, the IRS has recently stated that changes to the law made by the Community • The annual limit on participant compensation is Renewal Tax Relief Act of 2000 ( i.e. , changes to the increased from $170,000 to $200,000 effective for definition of compensation for certain qualified plan years beginning after December 31, 2001. transportation fringes) must be reflected in plans no later than the last day of the GUST remedial These benefit limit changes can be expected to amendment period. Plans must be operated in have significant consequences. For example: accordance with the GUST and Community Renewal • Subject Tax Relief Act changes prior to the adoption of actual to non-discrimination testing, the plan amendments. increased 401(k) contribution limit will permit This document is published by Lowenstein Sandler PC to keep clients and friends informed about current issues. It is intended to provide general information only. Roseland, New Jersey Telephone 973.597.2500 L 65 Livingston Avenue www.lowenstein.com 07068-1791 Fax 973.597.2400

G highly compensated employees to defer more of most participants choose to receive a lump sum their income. anyway. • The increase in the deductible limit for profit- • Effective for plan years beginning after December sharing plans makes money purchase pension plans 31, 2001, matching contributions can be counted less attractive. Any employer currently towards a top-heavy plan’s minimum contribution maintaining a money purchase pension plan should require-ments. This change will eliminate the need consider converting it into a profit sharing plan. to make minimum contributions under many top- heavy plans. • The increase in the annual benefit that may be paid • Effective for plan years beginning after December under a defined benefit pension plan can be expected to have substantial consequences for employers. 31, 2001, plan loans can be made to owner- Employers with supplemental “non-qualified” plans employees on the same basis as they are made to will be able to shift some of the liability for such non-owner employees. supplemental benefits to the tax-qualified plan. • Effective January 1, 2002, after-tax contributions Employers without existing supplemental plans can can be rolled over by participants to an IRA or restore benefits for key employees that were another qualified plan, thereby eliminating the need previously limited to $140,000 per year. to distribute after-tax contributions separately. However, employers must be cautious. The higher limit can also create an additional funding ESOP Changes obligation to the plan. Because the new limit The Act also includes provisions directed at automatically becomes effective for plan years employee stock ownership plans: beginning after December 31, 2001, employers must • Effective for taxable years beginning after promptly review their plans to determine whether the 2001 limit should remain in effect. Employers also December 31, 2001, an employer may deduct should consider adopting plan amendments before dividends paid to an ESOP if the dividends are January 1, 2002, to keep 2001 limits in place until the reinvested in employer stock, provided that impact of the increase can be evaluated fully. participants also have the opportunity to receive the dividends in cash. Under existing law, ESOP • The increase in the compensation limit will also dividends are not deductible unless used to repay have enormous consequences. Like the increase in an ESOP loan or distributed to participants. the pension annual benefit limitation, the increased • Under the Act, certain “disqualified persons” may compen-sation limit can also have a significant not be allocated stock under an ESOP maintained impact on funding obligations. The new compen- by an S corporation. sation limit should make it easier for 401(k) plans to pass non-discrimination testing require-ments, Conclusion thereby allowing highly compensated employees to Employers will have many important decisions to defer more of their income. make in determining how to apply the new law to their benefits plans. Since many of the new changes are Simplification of Plan Aaministration effective January 1, 2002 (for calendar year plans), the In addition to increasing many important benefit effects of the new law should be evaluated immediately. limitations, the Act includes a number of measures that will simplify plan administration and reduce While this Alert summarizes the benefits provisions of the plan costs: Act, the application of the law to each employer’s benefits program will differ on a case-by-case basis. To discuss • Defined contribution plans may be amended to how the Act affects your benefits program, please contact eliminate any optional form of distribution, so long Andrew E. Graw, head of the firm’s Employee Benefits as a lump sum option is retained or provided. and Executive Compensation Practice, at (973) 597- Employers with profit sharing plans should consider 2588 or at agraw@ lowenstein.com. eliminating installment and annuity options since 2