Comparing New and Old Rules for 401k Matching Contributions and After-Tax Contributions

Issue

Old 401k Law

Updated 401k Law

Faster Vesting of Employer Matching Contributions

Employers have a couple of choices when determining when employees are vested in their retirement plan's assets. However, employer Matching Contributions must vest at least as quickly as under a five-year “cliff” vesting schedule or a seven-year “graded” schedule.

Vesting in Employer Matching Contributions for a participant who completes one hour of service in a plan year beginning after December 31, 2001, must be calculated in accordance with a vesting schedule that provides vesting at least as rapidly as either under Three-Year Cliff Vesting (100% vesting after three years of Vesting Service) or Six-Year Graded Vesting (20% vesting per year beginning in the second year).

Catch-Up Contributions

Catch-Up Contributions are not allowed in 401k plans.

A plan that can permit deferral contributions generally can permit participants who are age 50 or older before the close of the plan year to make salary deferral, pre-tax, Catch-Up Contributions. These catch-up contributions are in addition to the participant's regular deferral contributions. The amount of Catch-Up Contributions start at $1,000 for 2002 and increase by $1,000 per year until they reach $5,000 in 2006. Thereafter, the maximum amount will be indexed in $500 increments. Catch-Up Contributions are not subject either to the actual deferral percentage test or the limit on annual additions, provided all employees 50 or older are eligible to make Catch-Up Contributions.

Employer Matching Contributions regarding to Catch-Up Contributions

Catch-Up Contributions are not allowed in 401k plans.

Plan sponsors can choose whether to provide Employer Matching Contributions regarding Catch-Up Contributions.

Any Employer Matching Contributions
on employees Catch-Up Contributions are subject to nondiscrimination rules.

Direct Rollovers into the plan of qualified plan after-tax contributions

Employees may not roll after tax contributions into a qualified plan.

A plan may permit a participant to elect a direct rollover into the plan of a distribution consisting of qualified plan after-tax contributions, provided the plan maintains separate accounting of these amounts, including earnings. This rule applies to distributions made after December 31, 2001.

Increase in Elective Deferral Limits

Employees are currently limited to a maximum of $10,500 (for the 2001 calendar year) in employee pre-tax elective deferrals under 401k plans

After 2007, the maximum elective deferral is subject to annual cost-of-living increases:

Limit on Plan Compensation

The annual compensation that may be taken into account in allocating contributions (employee, employer, and any reallocated forfeitures) for an eligible participant in a qualified retirement plan is limited to $170,000.

The annual compensation taken into account in allocating contributions (employee, employer, and any reallocated forfeitures) for an eligible participant in a qualified retirement plan is $200,000 and will be indexed annually in $5,000 increments. This provision is effective for plan years that begin after December 31, 2001.

Change in the treatment of Employer Contributions that are distributed as a result of a
Financial Hardship

Hardship distributions attributable to 401k deferrals may not be rolled over but such distributions from employer contributions may be rolled over.

Amounts distributed as the result of a financial hardship will not be eligible to be rolled over.
This rule applies to hardship distributions made after December 31, 2001.

Increase in Annual Additions Limits

Contributions (referring to contributions by an employee, employer, and any reallocated forfeitures) allocated to a participant's account for a limitation year in a defined contribution plan are limited to the lesser of $35,000 or 25% of the employee’s compensation.

The limit for contributions (from an employee, employer, and any reallocated forfeitures) allocated to a participant’s account for a limitation year are increased to the lesser of 100% of compensation or $40,000.
The $40,000 limit increases annually in $1,000 increments. These new limits apply to limitation years beginning after December 31, 2001.

Changing the definition of Key Employee and the Look-back Rule for Top-Heavy Testing purposes; Employer Matching Contributions can be used to satisfy the Top-Heavy Minimum Contribution requirements

What exactly is a top-heavy retirement? A retirement plan is considered to be top-heavy if at least 60% of the contributions/benefits are for “key employees.” Plan distributions that are made to key employees must be included in the top-heavy test for purposes of determining the 60% threshold. How can an employer rectify the situation if a plan is top heaby? If a plan is top-heavy, the employer is required to make a minimum contribution to all “non-key” employees eligible to participate. In addition, Employer Matching Contributions are not considered to satisfy the minimum employer contribution requirement.

1) Changes to the top-heavy rules include a revised definition of “key employee," and the reduction of the five-year look back rule to one-year for distributions after the employee's separation from service.

2) Employer Matching Contributions are taken into account in satisfying the minimum employer contribution requirement.

These new rules apply to plan years that begin after December 31, 2001.

Repeal of Multiple Use Test

The multiple use test combined 401k, after-tax, and employer matching contributions for highly compensated employees and subjected them to a nondiscrimination test.

The multiple use test is repealed, effective for plan years beginning after December 31, 2001.

Expansion of Eligible Rollover Distributions from the Plan

Asset amounts distributed from a 401(a) plan may only be rolled over to the same type of plan or to an IRA. Distributions consisting of after-tax employee contributions are ineligible for rollover to a qualified plan.

With regard to defined contribution plans, distributions from a 401(a) defined contribution plan will be eligible to be rolled over to any other defined contribution arrangement, including 403(b) and 457 plans. A distribution to a surviving spouse or an alternate payee under a qualified domestic relations order will be eligible for rollover. After-tax contributions will be eligible for direct rollover.

Expansion of Eligible Rollover Contributions to the Plan

Amounts distributed from a 401(a) plan may only be rolled over to the same type of plan or to an IRA. Distributions consisting of after-tax employee contributions are ineligible for rollover.

Plan distributions from any defined contribution arrangement, 401k, 403(b), 457, etc., will be eligible to be rolled over to any other defined contribution arrangement. Similarly, some non-conduit IRA distributions and distributions to a surviving spouse or alternate payee will be eligible for rollover into a 401(a) plan.
After-tax contributions will be eligible for direct rollover.

Loans for "Owner-Employees"

Regardless of an employees situation, loans are not available for "owner-employees."
An "owner-employee" is a self-employed individual, a partner with a 10% or more ownership interest in the partnership, or a 5% or more shareholder of a Subchapter S corporation.

Loans are available to "owner-employees," effective for plan loans made after December 31, 2001.

Change in the Contribution Suspension Period from 12 to 6 months after receipt of a Hardship Distribution