Take advantage of 2002 employee benefit changes

This year Congress passed and the President signed the Economic Growth and Tax Relief Reconciliation Act of 2001, for its income and estate tax changes.

However, what is not so well known about this act is that it substantially changed employee benefit plans, particularly 401(k) plans.

A 401(k) plan is a plan in which the employee elects to contribute a portion of his or her pay to a retirement plan for the benefit of the employee. In 2001, the maximum amount that can be contributed for each employee is $10,500 per year. Overall contributions, including the deferral amounts, are limited to the lesser of $35,000 or 25 percent of pay.

But all of these rules change next year.

The EGTRRA increases the amount of elective deferrals allowed beginning in 2002. The maximum deferral amount in 2002 is $11,000. That amount increases by $1,000 each year through 2006, at which time the maximum deferral amount is $15,000.

In order to help employees make additional deferral contributions, Congress also changed the overall limit on contributions to the lesser of $40,000 or 100 percent of pay. This will allow all employees who want to save for retirement to defer the maximum as permitted under the Internal Revenue Code.

Catch-up' contributions

If $11,000 in 2002 and $15,000 in 2006 are not enough, and if you are age 50 or older, the EGTRRA allows for additional "catch-up" contributions. The additional catch-up contribution limit is $1,000 in 2002 and increases $1,000 each year until it reaches $5,000 in 2006. Thus, in 2002, if you are over age 50, you can make $11,000 in regular deferral contributions and an additional $1,000 in catch-up contributions.

The catch-up contribution can be made even if the contribution amount would otherwise exceed the overall limit on contributions.

401(k) plans are required to be non-discriminatory. In order to ensure this, the Internal Revenue Code provides limits on the amount of contributions that highly compensated employees can make in the form of deferral contributions. The effect of this limit is that highly compensated employees may not be able to make the maximum deferral contribution allowed by law.

The permitted catch-up contributions may be very important for highly compensated employees because catch-up contributions may be made irrespective of the limits on deferral contributions under any other part of the Code.

Additional changes that will occur in 2002 relate to the minimum amount required to be distributed from a qualified plan and the rules surrounding distribution elections. The Internal Revenue Service recently published new proposed regulations changing the minimum distribution election rules. Prior to the change, a distribution election was irrevocable and could result in accelerating distributions and, therefore, income tax payable, if the beneficiary named in the election died prematurely.

Mandatory for 2001

The IRS's new proposed regulations were optional for qualified plans in 2001, but are mandatory for 2002. The option is with the plan and not the individual employee.

Under the previous IRS regulations it took an attorney, accountant, actuary and a computer to compute the best possible benefit election.

The new rules simplify the election process for everyone, reduce the amount that is required to be distributed and eliminate many of the post-death distribution and tax problems that arose as a result of elections required to be made when distributions were begun.

In 2002, the newly passed EGTRRA, with its increase of the maximum permissible contribution amount, its in-crease in the amount of the deferral contribution permitted and its catch-up contribution options, will let many plan participants significantly increase deferral contributions under their employers' 401(k) plans.

At the same time, the IRS's new proposed distribution regulations will simplify distribution elections, making the plan more beneficial to everyone.

(Jim McLeod practices estate planning, employee benefits and tax law at Lathrop & Gage LC in Springfield.)