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IRS Issues Proposed Regulations on "Catch-Up" Contributions to Tax-Favored Retirement Plans
By Fritz Richter, III, Esq., Bass, Berry & Sims PLC About the Author: Advisory Board Member Fritz Richter is a partner in the Employee Benefits Practice Group of Bass, Berry & Sims PLC, a law firm with offices in Nashville, Knoxville, and Memphis, Tennessee. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) added to the Internal Revenue Code (the Code) new Section 414(v), which allows participants, age 50 and older, to make "catch-up" contributions to certain tax-favored retirement plans. Proposed regulations issued by the IRS on October 22, 2001, clarify many of the issues facing plan sponsors who are considering adding catch-up contribution provisions to their plans. Plan sponsors will be permitted to rely on these proposed regulations until the IRS issues final regulations. What Are Catch-up Contributions? Catch-up contributions are additional elective deferrals that a participant age 50 and older will be allowed to make to certain tax-favored retirement plans beginning in 2002. The catch-up contribution provisions will not be mandatory, rather plans will be permitted, not required, to allow participants to make catch-up contributions. The following tax-favored retirement plans will be permitted to offer catch-up contributions:
However, eligible 457 plans sponsored by tax-exempt entities will not be permitted to offer catch-up contributions. The dollar limit for catch-up contributions to 401(k) plans, 403(b) tax-sheltered annuities, eligible 457 plans sponsored by governmental entities, and SEPs will be as follows:
The limit will be indexed for inflation for years after 2006. The dollar limit for catch-up contributions to SIMPLE 401(k) plans and SIMPLE IRAs will be as follows:
The limit will be indexed for inflation for years after 2006. Catch-up contributions will also be subject to a compensation limit. Under this limit, elective deferrals will not be treated as catch-up contributions to the extent that elective deferrals made by a participant under all plans of the employer exceed the participant's compensation for the year. Who will be eligible to make catch-up contributions? A participant will be able to make catch-up contributions if he or she is otherwise eligible to make elective deferrals under the plan and is age 50 or older. A participant who reaches age 50 at any time during a particular year is considered to be age 50 for the entire year for this purpose. Will catch-up contributions be limited by or subject to other provisions of the Code? Catch-up contributions will generally not be limited by any other provisions of the Code. These provisions include Section 415 of the Code which, for 2002, will limit contributions made to a qualified retirement plan, 403(b) tax-sheltered annuity, or SEP with regard to a participant to the lesser of $40,000 or 100 percent of his or her compensation. Catch-up contributions also will not be limited by Section 402(g) of the Code which, for 2002, will limit elective deferrals contributed by a participant to a qualified 401(k) plan, 403(b) tax-sheltered annuity, or eligible 457 plan sponsored by a governmental entity to $11,000. Another important provision, which will not apply to catch-up contributions, is the average deferral percentage or "ADP" nondiscrimination test at Section 401(k)(3) of the Code. Other provisions which will not affect catch-up contributions are the coverage test of Section 410(b) of the Code, the "top-heavy" rules of Section 416 of the Code, the SIMPLE 401(k) plan rules of Section 401(k)(11) of the Code, and the safe-harbor 401(k) plan rules of Section 401(k)(12) of the Code. However, a plan subject to the nondiscrimination rules of Section 401(a)(4) of the Code that offers catch-up contributions must satisfy a "universal availability" rule. This rule is satisfied if the plan permits each participant age 50 or older to make elective deferrals up to the otherwise applicable limit plus the applicable catch-up contribution limit. For example, for 2002, if all eligible participants are permitted under a plan to make elective deferrals up to $11,000 (or a lower limit set forth in the plan or resulting from the application of the ADP test) plus catch-up contributions up to $1,000, the universal availability rule is satisfied. As a practical matter, the universal availability rule could come into play where an employer sponsors more than one 401(k) plan. Under the rule, if the employer permitted catch-up contributions under one of the 401(k) plans, it would have to permit catch-up contributions under all of its other 401(k) plans. What if an employer sponsors more than one plan permitted to offer catch-up contributions? Some employers sponsor more than one tax-favored retirement plan permitted to offer catch-up contributions. For example, an employer may sponsor two or more 401(k) plans for different groups of employees or a 401(k) plan and a 403(b) tax-sheltered annuity. In such cases, the proposed regulations will require the aggregation of elective deferrals under all the employer's plans to determine whether the statutory limit and the catch-up contribution limit for such amounts is exceeded. Assume a participant defers $8,000 under his or her employer's 401(k) plan and $5,000 under the employer's 403(b) tax-sheltered annuity in 2002. For 2002, the statutory deferral limit will be $11,000 and the catch-up contribution limit will be $1,000. The participant's total deferral under the two plans is $13,000. Under the proposed regulations, $11,000 would be regular elective deferrals, $1,000 would be catch-up contributions, and $1,000 would be in excess of the catch-up contribution limit. When may plans start permitting catch-up contributions? Plans may start permitting catch-up contributions in tax years of the participant - not plan years - starting in 2002. A participant's tax year is almost always the calendar year. For example, this means that a plan with a plan year ending July 31, 2002, may start permitting catch-up contributions January 1, 2002. When and how should a plan be amended to permit catch-up contributions? Plan amendments to permit catch-up contributions will generally have to be made before the end of the 2002 plan year. If this deadline is met using "good faith" EGTRRA plan amendments, employers will have until at least the end of the 2005 plan year to make final amendments to their plans that comply retroactively with EGTRRA. A plan amendment is considered to be a "good faith" EGTRRA plan amendment if the employer makes a reasonable effort to take into account the requirements of EGTRRA based on a reasonable and consistent interpretation. The IRS has provided sample plan amendments which, if used by the employer or used by the employer in preparing customized plan amendments, the employer will be considered by the IRS to comply with EGTRRA's "good faith" plan amendment requirement. (See IRS Notices 2001-42, 2001-56, and 2001-57, which we told you about in the August and October 2001 issues of BCLN.) The IRS included in IRS Notice 2001-57 the following sample language to use in amending plans to permit catch-up contributions:
[A]ll employees who are eligible to make elective deferrals under this plan and who have attained age 50 before the close of the plan year shall be eligible to make catch-up contributions in accordance with, and subject to the limitations of, section 414(v) of the Code. Such catch-up contributions shall not be taken into account for purposes of the provisions of the plan implementing the required limitations of sections 402(g) and 415 of the Code. The plan shall not be treated as failing to satisfy the provisions of the plan implementing the requirements of section 401(k)(3), 401(k)(11), 401(k)(12), 410(b), or 416 of the Code, as applicable, by reason of the making of such catch-up contributions. Use of this sample language automatically satisfies EGTRRA's "good faith" plan amendment requirement. How will plans report catch-up contributions? On October 9, 2001, the IRS issued Announcement 2001-93, which explains how catch-up contributions should be reported for 2002. Catch-up contributions will be treated the same as other elective deferrals on Form W-2 (in box 12 using codes D through H and S). The IRS anticipates that catch-up contributions will be treated similar to other elective deferrals on Form 1099-R and Form 5498. Further details will be provided in the 2002 instructions regarding the reporting of catch-up contributions on these forms. Bottom Line Proposed regulations recently issued by the IRS provide guidance on implementing the new catch-up contribution provisions permitted by EGTRRA. The catch-up provisions are optional, but most employers that sponsor eligible tax-favored retirement plans have decided to, or are considering, providing for such contributions for participants age 50 and older. Although plans will not have to be amended to add the catch-up provisions before 2002, the administrative procedures necessary to implement these provisions must be in place before 2002. With the effective date less than a month away, employers that decide to add the catch-up provisions to their plans need to immediately resolve the administrative issues involved. More info on Benefits & Compensation Law for Nonprofits
Copyright 2002 M. Lee Smith Publishers LLC. This article is an excerpt from BENEFITS & COMPENSATION LAW FOR NONPROFITS. Benefits and Compensation Law for Nonprofits is designed to provide accurate and authoritative information in regard to the subject matter covered. It is published with the understanding that neither the author(s) nor its publisher is engaged in rendering legal, accounting, or other professional services through its pages. If legal advice or other expert assistance is required, the services of a competent professional should be sought. (From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a committee of Publishers and Associations.)
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