EGTRRA, EGTRRA, read all about it
Lesser, Gary S
The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001
The retirement plan portions of this new tax bill could have been called “Expectations Revisited.” Both Democrats and Republicans have been promising to pass this legislation for a year. During that time, we’ve elected a new President, revamped Congress, and had an unexpected early term change of control and leadership. Surprisingly, most of the ingredients of the tax bill have remained intact. Amazingly, the IRS issued a new set of proposed regulations regarding required minimum distributions (RMDs), most of which were immediately applicable. After all the rhetoric, we’ll take a look at what the bill means.
Various aspects were suggested as “certain”, “locked in” or as having “overwhelming bi-partisan support.” So, let’s first see what EGTRRA did NOT do:
1. No reduction: The excise tax for failure to take a required distribution from a retirement account (including IRAs) stays at 50%. The House wanted 10%.
2. No increase: Income limitations stay the same for determining IRA deductibility for individuals who participate in employer plans or who have spouses who do.
3. No increase: Income limitations for eligibility to contribute to Roth IRAs stay the same.
4. No increase: Income limitations (from $100,000 to $150,000) for eligibility to convert to a Roth IRA stay the same.
5. No change: An individual 70 1/2 or older will not be permitted to assign IRA benefits to a charity during his/her lifetime.
So then, what did EGGTRA do for retirement plans?
IRA – Individual Retirement Accounts:
1. Contribution limits will be increased in stages, starting in 2002. Taxpayers 50 and older will be allowed to make additional contributions. as noted.
After 2008, the $5,000 regular contribution limit is indexed for inflation
2. A new “Deemed” IRA in 2003: When an employer allows an employee to make a voluntary contribution to a separate account or annuity, this is a “deemed” IRA, or “deemed” to be an IRA. If a separate account or annuity is established under the plan, and the account (or annuity) otherwise meets the requirements of either a traditional IRA or a Roth IRA, then that separate account (or annuity) will be treated for all purposes of the Code as either a traditional or Roth IRA. Eligibility to contribute to the deemed IRA will still follow current income limitations.
401(k), 403(b), 457 Plans (and defined contribution clans):
1. Elective contribution limits. These will be increased in stages for these plans, starting in 2002. As with IRAs, taxpayers who are 50 years or older will be allowed to make additional contributions.
Elective contribution limits for both the regular and 50 or over contributions will be indexed for inflation after 2006. Furthermore, the additional contributions for the 50 or over contributors will not be subject to anti-discrimination rules or other limitations, except that contributions may not exceed earnings. For instance, an employee who is over age 50 could contribute an extra $1,000 even though other plan provisions may limit the 401(k) contribution, for instance, to $6,500.
2. Maximum contribution: $40,000. Effective in 2002, the maximum contribution to a defined contribution plan will be $40,000. This will be indexed for inflation in $1,000 increments. (Currently, indexing is in $5,000 increments.)
3. Maximum compensation: $200,000. Effective in 2002, the maximum amount of compensation that can be used to determine a contribution to a defined contribution plan will be increased to $200,000. Thereafter, this level will be indexed for inflation in $5,000 increments. (Currently, indexing is in $10,000 increments.)
4. Maximum percentage of compensation: 25%. Effective in 2002, the maximum percentage of compensation that can be contributed and deducted (based on aggregate compensation of all participants) to a profit-sharing plan (including SEP, if a technical correction is passed that allows the more than 15% of includible compensation to be excluded from a participant’s gross income under Code Section 402(h), is increased from 15% to 25%. This will affect:
– The self-employed or small business owner, who will not need a money purchase pension plan in order to maximize his/her contributions.
– The owner with compensation above the maximum ($200,000 in 2002) and utilizing a profit-sharing arrangement, who will be able to reduce his/her percentage contribution, contribute the maximum and reduce the contributions for other employees.
5. Availability: Effective in 2002, matching contributions in a 401(k) must become fully available to the plan participant after three years of service (or, six years, if the employer contributions vest gradually). Currently, the vesting schedule is five and seven years, respectively
6. Roth IRA: Effective 2003, a Roth 401(k) and Roth 403(b) will be available in which there is no deduction for contributions and allow tax-free withdrawals at retirement.
7. Portability: The distinction between 401(k)/profit sharing, 403(b) plans, and governmental 457 plans is further blurred with the ability to comingle assets. This will make it easier for employees to move from for-profits to nonprofits and/or government employment.
Elective contribution limits: Limits will increase incrementally starting in 2002. Plan participants age 50 and over will be able to make additional contributions as noted:
The $10,000 regular contribution limitation will be indexed for inflation in $500 increments starting in 2006. In addition, the limitation for those over 50 will be indexed in $500 increments starting in 2007.
Defined Benefit Plans:
Annual maximum benefit: The annual maximum benefit will increase to $160,000, effective in 2002. This annual maximum benefit will be reduced for retirement before age 62 and increased for retirement after age 65.
529 State Savings Plans:
Tax-free withdrawals: Effective in 2002, withdrawals for qualified tuition and room and board expenses will be exempt from federal taxes. Furthermore, there is no income limit. Currently, these withdrawals are free of state taxes but subject to federal taxes at the student’s rate.
A change in the application of the new proposed regulations:
It was originally reported that application of the new Proposed RMD Regulations (i.e., with slower withdrawals) could take place without immediate amendment of the plans. The IRS has now stated that plans must be amended by year-end, since terms of the plan govern distributions. (Note: IRAs do not need to be amended to calculate mandatory minimum distributions.) Relief: To the extent that the payout from an unamended plan exceeds the amount due under the new regulations, a plan participant can roll the excess amount into an IRA within 60 days of its receipt.
All plans must be amended by the end of the 2001 plan year to comply with recent law changes and Proposed Regulations. It is reported that the IRS will not grant further extensions after the current plan year ends. On the other hand, it is expected that the anticipated 200,000 requests for determination letters will seriously strain resources at the IRS. This may result in only cursory reviews of applications.
As with most tax bills, EGTRRA has many nuances that will take months (years?) to understand and apply. We should understand that ERISA is still the primary legislation affecting retirement plans. The advantage we had with ERISA was that its retirement plan provisions were reviewed and discussed at great length and negotiated all prior to passage. Thus, EGTRRA plus the new Proposed Regulations give us the opportunity for analysis, planning, and updating clients’ financial plans.
William A. Clemmer and Gary S. Lesser, JD, head up Financial Services Agency Consulting (FSAC), a division of The Rough Notes Company. Clemmer has more than 25 years of financial services industry experience on Wall Street. Lesser writes and lectures widely on retirement planning and taxation issues. He is a member of the board of advisors for the Journal of Taxation of Employee Benefits.
Copyright Rough Notes Co., Inc. Aug 2001
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