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February 3, 2003
White House Proposal Would Overhaul Rules
for Defined Contribution Plans and IRAs |
President Bush’s budget proposal would offer sweeping reforms for employer-sponsored defined contribution retirement plans and IRAs. In a detailed press release issued January 31, 2003, the Treasury Department summarized the major elements of the Administration’s proposal to simplify and expand the nation’s tax-favored savings strategy.
Perspective. Whether the Administration’s budget package, including the retirement savings changes encompassed therein, will actually become law is anyone’s guess. What is clear, however, is that if any of the major provisions is enacted into law as proposed, the entire tax law landscape affecting qualified retirement plans and IRAs will appear quite different from the past.
New Personal Savings Vehicles. The Administration’s proposal would create two new savings arrangements “Lifetime Savings Accounts”, or LSAs, and “Retirement Savings Accounts”, or RSAs. LSAs could be used for any type of saving, and RSAs could be used only for retirement savings. Contributions to either an LSA or a RSA would be nondeductible, but earnings would accumulate tax-free. Any individual could contribute up to $7,500 per year to his or her LSA, regardless of income. All distributions from an LSA would be tax free, regardless of the individual’s age or the use of the distribution. Annual contributions to a RSA could not exceed the lesser of $7,500 or the individual’s includible compensation. An individual could contribute to a RSA regardless of the level of his or her income. All distributions from an RSA after age 58, or in the event of death or disability, would be excluded from taxable income.
The proposal contemplates that existing medical savings accounts and education and tuition savings plans would be converted into LSAs. Existing Roth IRAs would be renamed RSAs, and existing traditional IRAs and nondeductible IRAs could be converted into RSAs (but would not have to be converted). Existing IRAs that are not converted could not accept any new contributions.
The LSA and RSA provisions would become effective in 2003.
The Treasury Department’s press release includes some Q&A’s that discuss the new LSAs and RSAs further, and explain the conversion options. Click here to view the Treasury release: http://www.treasury.gov/press/releases/kd3816.htm
New Rules for Employer-Sponsored Plans. Working upon the assumption that simplification of the existing compliance rules for qualified plans will result in more employers adopting retirement plans, the White House proposal would make dramatic modifications to the existing law. Following are some of the most significant changes to the present tax law (and please again refer to the above link for some explanatory Q&A’s):
- Notably, the proposal makes no changes to defined benefit plans (the following items apply only to defined contribution plans).
- The top-heavy rules would be repealed.
- All defined contribution plans that permit employee deferrals/contributions would be consolidated into a single vehicle, known as “Employer Retirement Savings Accounts” or ERSAs. All 401(k), 403(b) and governmental 457 plans, as well as SIMPLE IRAs and SARSEPs, would fall under a single set of simplified rules and become ERSAs.
- ERSA deferral limits would track the existing 401(k) annual limits (i.e., $12,000 for 2003, increasing to $15,000 by 2006, plus the over age-50 catch-up contributions (i.e., $2,000 for 2003, increasing to $5,000 by 2006).
- Existing ADP and ACP testing would be replaced by a single nondiscrimination test. If the average contribution percentage for NHCEs is 6% or less, then the average contribution percentage for HCEs could not exceed twice the average for NHCEs. But if the NHCE average were in excess of 6%, the HCE average would be unlimited (i.e., no testing). (“Contribution percentage” would be calculated for each employee as the sum of all employee and employer contributions divided by the employee’s compensation.) An employer could avoid even this more liberalized testing through a safe harbor feature that is similar to existing 401(k) safe harbor rules (3% employer contribution, or a match of essentially 50% of the first six percent of deferrals). (See the link for Treasury’s Q&A on this feature.)
- The only coverage test for defined contribution plans would be the ratio percentage test whereby the percentage of NHCEs covered would have to be at least 70% of the percentage of HCEs that are covered by the plan. (The general test and the average benefit test would be repealed for DC plans.)
- The definition of highly compensated employee would be revised simply to mean any employee who for the prior year earned more than the Social Security Wage Base for that year.
- A single, uniform definition of compensation would apply, namely the W-2 compensation (plus employee deferrals).
- Cross-testing (“new comparability”) and permitted disparity would no longer be allowed for DC plans.
- The ERSA and other defined contribution plan changes would become effective for years beginning after December 31, 2003.
Commentary: As is readily apparent, these proposed revisions to present law are not cosmetic changes. Almost immediately after the details of the proposal were announced, various interest groups, expectedly, voiced strong misgivings about some or all of it. In other cases, critics have offered elaborate praise for the Administration’s good intentions to simplify the private pension system, but the same parties are coldly critical in their assessment of how the proposal would impact overall pension coverage, especially for smaller companies. It is still too soon to predict how these retirement and savings features of the Administration’s budget proposal will play out in the legislative process. NRS will continue to keep you apprised of developments regarding this important topic.
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