bmcper 
CEO/Auditor
Posts: 85
(6/28/01 9:29 pm)
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401K Update !!!
Tell the boss to ramp up your retirement plan
The new tax law includes many provisions to help you save more for your future. The trouble is, your company has to rewrite your 401(k) plan before you can get the benefits.
By Tom Woodruff
If you’re thinking about retirement and want to be able to add more to your 401(k) or similar fund, the new tax law is your best friend. You can save more, and if you’re just getting started on building a retirement nest egg, you can play catch-up for not saving enough in the past.
There’s one sizable hitch: Whether you can take advantage of these new incentives depends on decisions your boss may make between now and January.
The bounty of incentives for workers to save more for retirement is to start kicking in on Jan. 1 of next year. In addition to increasing the caps on how much we can contribute to 401(k)-type plans and IRAs, the incentives allow procrastinators 50 and older to contribute an additional $5,000 per year to their plans. But while the new tax law permits higher contributions, your retirement plan may not. Your employer must amend the plan so you can take advantage of these new provisions.
“We can expect a lot of mid- and upper-income workers to go to their companies to ask for changes to their plans,” says James Delaplane, vice president for retirement policy with the American Benefits Council, a trade organization for corporate benefit plans.
Delaplane believes that most plans will implement the $5,000 catch-up provisions right away, because Congress exempted these add-on amounts from complicated nondiscrimination testing provisions of the Employee Retirement Income Security Act (ERISA), the federal law that governs how most private pension systems work.
The only barrier to plan providers who want to add the catch-up provisions may be their record-keeping ability, since the amounts added through catch-up provisions must be recorded separately.
While most of the attention paid to the new retirement provisions has focused on increases to the maximum contribution limits, little has been devoted to a provision that is potentially more important. Congress eliminated a provision in the tax code that limited the combination of employer and employee contributions to retirement plans to 25% of total compensation.
Under the new law, all employees, regardless of earnings, can put “salary reduction” amounts into their plans up to the maximum permitted. In 401(k), 403(b) and 457(b) plans, those amounts will be $11,000 in 2002, with increases of $1,000 each year until 2006, when the maximum hits $15,000. The total will be adjusted for inflation in $500 increments after 2006.
Two-earner couples can really benefit
Critics of the new caps have complained that the higher caps primarily benefit highly compensated workers who would be willing and able to contribute more. The real beneficiaries, however, may be two-earner couples. Consider a couple where one spouse earns $75,000 a year and the other earns $40,000. Under the old law, the higher earner would be able to contribute the maximum to a 401(k) ($10,500), but the lower earner would not. Under the new law, they both would be able to contribute the maximum. That is, of course, if their employers amend their 401(k) plans.
Why employers may not agree
Amending a plan may not be a slam-dunk. Some employers may worry about failing to comply with ERISA’s non-discrimination tests if they permit every employee to contribute the maximum, said Randy Hardock, a Washington, D.C., attorney and former tax counsel to the Senate Finance Committee. Why? If the ERISA nondiscrimination tests show the plan primarily benefits the owner and the highly compensated employees, then the plan may have to return some of the contributions that these people have made -- or risk losing its tax qualification with the IRS. The most critical test is to compare how much the owner and top compensated employees contribute to a plan with the rank and file. If the top employees are contributing too much, the plan can fail. The cash must then be returned, and the employees lose a potentially nice tax break.
“Employers hate having to return contributions to their highly compensated employees,” says Ed Ferrigno, vice president of Washington affairs, for the Profit Sharing/401(k) Council of America (PSCA). Ferrigno says that many employers limit the amount that their highly paid workers can contribute to 401(k)-type plans because they’re afraid they might fail the tests, have to return money and face disgruntled executives. So, even though the law may allow greater contributions, employers often limit total employee contributions to 10% to 12% of pay.
The fact is that most employers and employees are not even taking advantage of current limits. According to a 1999 survey by the PSCA, the average employee contributes just 5.4% of gross pay to 401(k) and profit-sharing plans. Average employer contributions were just 4.7% of pay. Another 1999 survey of large 401(k) plans conducted by Hewitt Associates showed average employee contributions of 6.7% to their plans.
Another issue facing 401(k) and similar plans is how the law affects traditional contribution formulas. Most companies base their contribution formulas on percentages of total compensation. You can contribute up to, say, 9%, and your employer will match up to 4% of your base salary or wage. The new tax law eliminates the percentage limits. The most recent Hewitt Associates survey showed that about 32% of employers anticipate having to limit contributions by highly compensated employees because the contributions would violate ERISA standards.
How you might still get to contribute more
Three possible solutions to the contribution dilemma might still give you the maximum contribution limit you want.
Encourage lower-paid employees to contribute more as a percentage of pay. That way, the higher-paid employees could also contribute more and not cause the plan to run afoul of ERISA.
How can lower-paid workers be encouraged to pay more? One answer can be found in the new tax law itself. For the years 2002-2006, low- and moderate-income taxpayers can receive a targeted, nonrefundable tax credit -- in addition to normal deductibility for the contributions -- for the first $2,000 contributed to a retirement plan. Here is the schedule:
Credit Individual adjusted
gross income Joint adjusted
gross income
50% $0-$15,000 $0-$30,000
20% $15,001-$16,250 $30,001-$32,500
10% $16,251-$25,000 $32,501-$50,000
These are substantial incentives. Employers armed with illustrations of how little it will really cost lower-income workers to contribute to their plans might very well boost participation.
Change the matching formula altogether. One method might be to have employers matching on absolute dollar amounts rather than percentage of pay. Under this arrangement, an employer might match 50 cents for every dollar contributed up to, say, $5,000. This could lead to higher percentages of pay for lower-paid workers, increasing the likelihood that the plan would pass the ERISA test.
Adopt a safe-harbor 401(k) plan design. Under this approach, Ferrigno says, plans automatically meet the ERISA standards by the way they are designed rather than by what individual participants actually do.
With a safe-harbor 401(k), the employer chooses one of two plan designs:
All eligible employees receive an employer contribution of 3% of compensation. The employer contribution is 100% vested. Every employee is then free to contribute as much as he can, up to the maximum determined by law.
The employer matches dollar for dollar for the first 3% of employee contributions, plus 50 cents for each dollar of employee contributions for the next 2% of salary. The employer contribution is 100% vested. Every employee is then free to contribute as much as he or she can, up to the maximum determined by law.
Big winners: Employees at nonprofits
Employees at nonprofits who contribute to 403(b) retirement plans will be able to take advantage of the new limits right away. Unlike 401(k) plans, employers often offer two types of 403(b) plans: core plans that accept employer matching contributions and supplemental plans that only accept elective employee contributions. Private colleges and universities, many state colleges and universities, and charitable organizations often offer both plans to employees. Public-school teachers and some state colleges and universities often offer a core state retirement plan and then a supplemental 403(b) plan. Regardless of what employers do with the core 403(b) plans, nonprofit employees will be able to contribute the full maximums starting Jan. 1, 2002 by increasing their contributions in the supplemental 403(b) plans.
R.I.P. Keogh plans?
A footnote to the new tax law: Keogh plans (also called “money purchase plans”) may be dead. Keogh plans have been popular with self-employed professionals like doctors and lawyers because they can contribute greater amounts than they might contribute to SEP IRAs and other retirement-savings vehicles. In recent years, companies like Fidelity Investments have promoted combination Keogh/profit-sharing plans. Actually, these are paired but legally separate plans, because they offered maximum annual flexibility for contribution amounts while still allowing the self-employed and small business owners to defer the maximum amount (lesser of 25% of compensation or $35,000 a year).
The elimination of the percentage limit now makes this design obsolete. Now the self-employed and small businesses can get the same flexibility and maximum deferral with just one plan -- the profit sharing plan.
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