On June 7, 2001 President Bush signed into law his $1.35 trillion dollar tax cut, HR 1836, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGATRRA2001). On May 26, 2001, it passed both the House of Representatives (230-197) and the Senate (58-33). The non-controversial pension provisions from Portman-Cardin that passed the House twice with over 400 votes each time were included in the sweeping tax reduction and reform bill. Most of the provisions from previous versions survived and the end result from the Joint House–Senate Conference Committee produced a better result than the versions they were given to reconcile.

This is a package of retirement savings and pension reform initiatives that will encourage the establishment and maintenance of retirement plans for many years to come. The nation’s pension community worked long and hard for these enhancements, and most practitioners are quite pleased with the results. If this were a stand alone bill and not part of the big tax package, it doubtless would have passed both houses by overwhelming margins.

The new law increases IRA, 401(k), and other plan contribution limits, permits catch-up contributions to certain accounts, and modifies the rules to increase participation and enhance portability. In addition to the above, there a few minor technical corrections as well. These are the most comprehensive changes in pension law since ERISA was passed 27 years ago, and the positive impact of this new law on the private pension system will be enormous.

The following are the pension provisions of HR 1836. Unless specifically noted, all provisions are effective for taxable years beginning AFTER December 31, 2001.

Also, since this is part of the big tax package, the provisions do NOT apply to years beginning AFTER December 31, 2010 (the “sunset” provision), although no one really believes that will happen!

A. Annual Dollar, Deferral and Benefit Limits

Dollar and Benefit Limits

The annual compensation limit is increased from $170,000 (in 2000 and 2001) to $200,000 for 2002 (subjected to indexing in $10,000 increments after 2002).

The Annual Additions dollar limit (IRC Section 415) for Defined Contribution (DC) plans increases from $35,000 in 2001 to $40,000 in 2002. This limit is subject to indexing in $1,000 increments (rather than $5,000 increments under current law).

The Annual Additions (IRC Section 415) compensation limit for DC plans increases from 25% to 100% for 2002 and after. That makes the DC limit 100% of pay not to exceed $40,000 for the year 2002. Also, the annual contribution limit for 457 plans increases from 33 1/3% of compensation to 100%.

The annual benefit dollar limit for Defined Benefit (DB) plans (IRC Section 415) increases from $140,000 in 2001 to $160,000 for 2002 and thereafter. Reductions will occur only if the benefit starts before age 62, rather than before the social security retirement age. The benefit dollar limit increases if benefits start after 65, rather than after the individual’s social security retirement age. The limit is subject to indexing in $1,000 increments. The DB limit applies to plan years ending AFTER December 31, 2001.

Deferral Limits

The 401(k), 403(b) and 457 elective deferral dollar limit increases from $10,500 in 2001 for 401(k)’s and 403(b)’s ($8,500 for 457 plans in 2001) to $15,000 (starting with $11,000 in 2002, increasing $1,000 per year until it is at $15,000 in 2006 and thereafter). The limit is indexed in 2007 and thereafter in $500 increments.

Also, eligible 457 plan participants don’t have to coordinate the 457 deferral limit with the deferral limit for 401(k) and 403(b) plans, starting in 2002.

The elective deferral dollar limit for SIMPLE-IRA and SIMPLE 401(k) plans increases from $6,500 in 2001 to $10,000 (starting with $7,000 in 2002 and increasing $1,000 annually until it’s $10,000 in 2005). This limit is subject to indexing in $500 increments after 2005.

There are additional catch up deferrals allowed for those who have attained age 50 by the end of the year. The additional catch up amounts are $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 for 2006 and after. For SIMPLE IRAs and SIMPLE-401(k)’s, the catch up amounts are 50% less than the above amounts. You must first make the maximum deferral that the law or the plan allows first.


The catch ups are not subject to any other contribution limits or non-discrimination rules. The Employer may make a tested matching contribution on these amounts, and the ability to make a catch up contribution must be made available to all participants.

In an item of enormous significance to 403(b) plans, the maximum exclusion allowance (MEA) for 403(b)’s is repealed, so that 403(b) plan participants are limited only by the elective deferrals limit and the overall IRC Section 415 limit on contributions.

B. Deductions

The maximum deductible limit under IRC Section 404 for contributions to profit sharing plans increases from 15% to 25% of the compensation of eligible participants (the participating payroll). Participant compensation used to calculate this limit is IRC Section 415 compensation, meaning it is “grossed up” for employee elective deferrals made to 401(k), 403(b), SIMPLE, and 457 plans. So, the compensation definition includes the deferrals.

This limit applies to all defined contribution plans, including money purchase and target benefit plans, for post-2001 taxable years, although Treasury can create exceptions to the 25% rule for money purchase and target benefit plans.

C. IRAs (Traditional and Roth)

IRA contribution limits are increased from $2,000 in 2001 to $3,000 for 2002 through 2004, $4,000 for 2005 through 2007, and $5,000 for 2008 and after, with indexing in $500 multiples after 2008.

For individuals age 50 or older before the close of the taxable year, an additional catch up contribution is allowed. The additional contribution is limited to $500 for 2002 through 2005, and $1,000 for 2006 and thereafter. There is no indexing of the IRA catch ups.

That makes the total IRA contribution limit for those individuals age 50 or older $3,500 in 2002 through 2004, $4,500 for 2005, $5,000 for 2006 and 2007, and $6,000 for 2008.

Voluntary employee contributions to a qualified (401(a)) plan, 403(b), or 457 plan are to be treated as traditional or Roth IRAs (“Deemed” IRAs) and would be subject to all the ERISA rules. (Effective for plan years after 12/31/2002)

D. Participant Loans

This provision permits unincorporated sole proprietors, partners, LLCs, and S Corporation shareholders that are plan participants to have participant loans.

E. Top Heavy Plans

The bill simplifies the key employee definition for top heavy by eliminating the “top 10 owner test”. An employee will not be treated as a key employee based on his/her officer status unless the employee earns more than $130,000 (indexed in $5,000 increments starting in 2003). Also repealed is the definition of key employee as one of ten employees earning more than the IRC 415(c) limit and owning the largest interests in the employer.

So, a key employee becomes an officer making over $130,000, a 5% owner, or a 1% owner with compensation in excess of $150,000.

The top heavy rules do not apply at all to plans consisting solely of 401(k) safe harbor deferrals and 401(m) safe harbor matching contributions.

Also, the bill eliminates the 4-year look back to determine who is a key employee.

Matching contributions will count toward satisfying the top heavy minimum contribution limit and are still counted in the ACP nondiscrimination test.

Top heavy testing would use only a 1-year look back (rather than a 5-year look back) to include prior distributions from the plan (including terminated plans). However, in-service distributions are still subject to the 5-year look back. Also, to determine an employee’s years of service, service during a plan year when no employee or former employee benefits under a plan is disregarded.

Top heavy minimum accrued benefits under a defined benefit plan are not required for any plan year that the plan is a frozen plan.

F. Roth 401(k) & 403(b) Plans

New “Roth 401(k)” and “Roth 403(b)” arrangements are allowed starting in 2006.

Similar to Roth-IRAs, the employee passes on the income tax deduction for the elective deferral to the 401(k) and 403(b) plan and in exchange receives tax-free distributions attributable to the elective deferral (and income attributable to such deferral). This is permitted provided the plan separately accounts for the contributions (called “Plus Contributions”). Also, the withdrawals can be taken only after a “Qualified Distribution” similar to Roth-IRAs which can only occur after the five taxable years from the year in which the first contributions are deposited by the employee and only if withdrawn after age 59-1/2 or because of death or disability. You can make these Plus Contributions in lieu of all or a portion of the elective deferrals made to the 401(k) or 403(b) plan, and the deferral, catch up rules, and the ADP test (401(k)) apply to these contributions as well.


Qualified Plus Contribution accounts could be rolled over only to another qualified plan that permits such accounts or to a Roth-IRA and Qualified Roth contributions would be treated as elective deferrals for purposes of applying the ADP test. Both Roth 401(k) and 403(b) contributions (and earnings) can be rolled over to a Roth IRA.

This proposal would be effective for tax years beginning 1/1/2006 and after.

G. 401(k) Plans

Employers can deduct regular 401(k) contributions and employee deferrals without reducing the deduction limit for other employer contributions to profit sharing plans. The 25% deduction limit still applies to other employer contributions, such as matching contributions or discretionary non-elective contributions, and the 25% deduction limit would be determined by including elective deferrals in the definition of compensation.

The multiple use test for 401(k) plans is essentially eliminated.

IRS is required to amend its regulations regarding 401(k) hardship withdrawals to reduce the suspension period for the participant’s deferrals from 12 months to 6 months. These assets would not be eligible for rollover.

H. Distributions

Treasury is required to modify the minimum required distribution regulations to reflect increases in current life expectancy and revise required distribution methods so, using reasonable assumptions, the amount of the required minimum distribution does not decrease over a participant’s life expectancy.

Distributions in 401(k), 403(b), and 457 plans can occur upon severance from employment rather than separation from service. For 401(k) plans, this fixes the “same desk rule” to determine whether an employee has a distributable event from a 401(k) plan. This simplifies issues relating to whether distributions could be made from a 401(k) plan maintained by a company being acquired by another company that will offer employment to the seller’s employees but will not maintain the seller’s plan.

I. Rollovers

Rollovers are permitted between all types of employer-sponsored plans (qualified plans, 403(b) plans, 457 plans) as well as IRAs. The conduit IRA is required in order to preserve proper tax treatment of a plan distribution. Rollovers from qualified plans or 403(b)’s into 457’s will remain subject to the 10% penalty tax for premature distributions.

Trustee to trustee transfers of after-tax employee contributions can be made to a new employer’s defined contribution plan, as long as the new employer ‘s plan separately accounts for them.

After-tax employee contributions can be rolled over from qualified plans to traditional

IRAs or other qualified plans. It must be a direct rollover between qualified plans.

However, they can not be rolled over from an IRA into a qualified plan, 403(b), or 457 plan.

Treasury has to prescribe rules to carry out these provisions, and notices to participants are required for the above plan types.

Treasury can waive the 60-day rollover period if the failure to waive such requirement is against equity and good conscience, including events beyond the reasonable control of the individual subject to the requirement.

Account balances can be transferred from one DC plan to another without causing the transferee plan to be required to preserve the optional forms of benefit previously available under the transferor plan, subject to certain conditions, and provided the transferee plan includes a single sum payment option.

Also, rollovers are excluded from the involuntary cash-out limit. A participant could be involuntarily cashed out so long as the non-rollover vested account is $5,000 or less, even though the total vested account exceeds $5,000 when the rollover is taken into account.

Direct rollovers would be the default option for involuntary cashouts that exceed $1,000 and that are eligible rollover distributions from qualified plans. They would be rolled over automatically to a designated IRA unless the participant elects otherwise. The US Labor Department must issue regulations with regard to investments in the default IRA so the plan is relieved from fiduciary liability with respect to such rollover. This provision can not take effect until after the Labor Department issues those regulations.

J. Faster Vesting of Matching Contributions

This provision requires employer matching contributions under non-top heavy plans to vest at least as rapidly as under the three year/100% vested or the six year grading vesting schedule (20% in year two to 100% in year six). This rule only needs to apply to a participant with at least one hour of service credited after the effective date of this new rule.

K. Defined Benefit Plans

Total repeal of the “155% of current liability” full funding limitation for the 2004 plan year (with phase-out in 2002 and 2003).

Also, IRC Section 404(a)(1)(D) is changed to allow funding up to the un-funded termination liability rather than un-funded current liability, and would be available to all plans regardless of size, provided the PBGC insurance program covers the plan.

At the employer’s election, no excise tax would apply to nondeductible contributions made by an employer to a defined benefit plan in excess of the current liability full funding limit.

Finally, the timing of plan valuations is modified to allow election from same plan year to one year prior to beginning of plan year if value of assets are not less than 125% of the plan’s current liability.

L. Determination Letter User Fee Relief for Small Employers

There is a waiver of user fee for determination letter requests for qualified 401(a) plans made by small employers with 100 or less employees who have a least one non-highly compensated employee (similar to the SIMPLE plan rules). This is only available for requests made in the first five years of the plan’s existence or at the end of a remedial amendment period, if later, that began during that first five years.

M. No Remedial Amendment Period Prescribed

No remedial amendment period regarding plan amendments was prescribed by the statute! However, it’s expected that the IRS will prescribe an extended amendment period. It’s too soon to tell if the IRS will extend the current GUST amendment period to conform to the EGATRRA2001 amendment period.

N. Treatment of Employer Provided Investment Advice

Qualified retirement planning services provided to an employee and his or her spouse by an employer maintaining a qualified plan would generally be excludable from income and wages provided it is available to all employees on substantially the same terms.

O. Notice of Significant Reduction in Benefit Accruals

This provision was triggered by recent actions by employers who converted plans to cash balance or other hybrid formula plans. This enhances the ERISA Section 204(h) 15 day notice requirement that requires advance notice in the event a pension plan (defined benefit, money purchase, target benefit) significantly reduces the rate of future benefit accruals.

This provision requires that an enhanced ERISA 204(h) written notice be supplied to plan participants in advance of an amendment to any defined benefit plan that significantly reduces the rate of future benefit accruals.

The enhanced notice changes the 15 day requirement to a reasonable period before the effective date of the amendment. An excise tax of $100 per day per participant would apply if the required notice is not provided. The excise tax can be waived for certain failures where the employer has exercised “reasonable diligence”. The explanation must be written in a manner that is understood by the average plan participant.

A simplified notice may be designed by the Department of Labor (DOL) or DOL may exempt from the notice requirement plans with fewer than 100 participants or plans that let all employees choose between the old and new benefit formulas. This notice must include reductions in early retirement benefits and subsidies as well. This is effective on the date of enactment.

P. Credit for Low-Income Savers

The bill provides a temporary nonrefundable tax credit for contributions made by eligible lower income taxpayers of up to $2,000 in contributions made to an IRA, Roth IRA, 401(k), 403(b), SIMPLE, SEP or 457 plan.

For joint filers, the credit starts at 50% (with a $2000 maximum) for Adjusted Gross Incomes (AGI) of $30,000 or less, 20% credit for AGI of $30,001 to $32,500, 10% credit for AGI of $32,501 to $50,000, and phased out completely for AGI over $50,000.

For single filers, the credit starts at 50% (with a $1000 maximum) for Adjusted Gross Incomes (AGI) of $15,000 or less, 20% credit for AGI of $15,001 to $16,250, 10% credit for AGI of $16,251 to $25,000, and phased out completely for AGI over $25,000.

A similar phase out schedule exists for Head of Household filers with AGI’s of $37,500 or less.

This provision has no impact on plan administration.

This provision is effective for taxable years beginning after 12/31/2001, and before 1/1/2007(only for the 2002 through 2006 tax years).

Q. Small Business Tax Credit for New Retirement Plan Expenses

Small businesses with 100 employees or less who each have compensation of $5,000 or more would be eligible for an annual tax credit in lieu of a deduction. This credit can not exceed 50% on up to $500 of administrative and retirement education expenses costs for the first three years of a new plan (including qualified plans, SEPs, and SIMPLEs).

This credit applies to plans established after 12/31/2001 that have at least one non-highly compensated employee.

R. Modifications to Education IRAs

The annual contribution limit goes up from $500 to $2000. Contributions can be made by April 15 of the following year, rather than BY December 31. The definition of qualified education expenses is expanded, the phase out AGI for married participants filing jointly goes from $190,000 to $220,000, special needs persons don’t have to take the money by age 30, and coordination with Hope, Lifetime Learning Credits, and state tuition programs would be required.

Also, these apply to elementary and high school as well as to college tuition. Covered expenses include tutoring, computer equipment, room and board, uniforms, and extended day program costs.


Ron E. Merolli, JD
National Director, Qualified Plans
Estate & Business Planning
Allmerica Financial
440 Lincoln Street
Worcester, Massachusetts 01653