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Thelen Reid Brown Raysman & Steiner LLP
Beginning
January 1, 2002, participants over age 50 may contribute
additional elective deferral "catch-up contributions"
to 401 (k), 403 (b), 457, SIMPLE IRA or salary reduction
SEP plans. On October 22, 2001, the IRS proposed regulations
explaining how the catch-up rules work. Employers can rely
on these proposed regulations until further guidance is
issued.
What
Is a Catch-Up Contribution? A catch-up contribution
is a pre-tax contribution that exceeds the annual elective
deferral limit ($11,000 in 2002 for non-SIMPLE plans), the
§415 limit (100 percent of pay or $40,000), any plan-imposed
limit (such as a payroll period percentage limit) or the
limit imposed by non-discrimination testing.
Who
Is Eligible? A participant eligible to make pre-tax
contributions may make catch-up contributions during any
calendar year ending with or after the participant's 50th
birthday.
What
Is the Limit? An individual's total catch-up contributions
during 2002 cannot exceed $1,000. This limit increases by
$1,000 each year until it reaches $5,000 in 2006. After
2006, the limit will be indexed for inflation.
When
Is the Catch-Up Computation Made? The catch-up limit
applies on a calendar year basis. Plans characterize contributions
as catch-up contributions at the end of the plan year unless
the contribution exceeds the elective deferral limit when
made.
How Are Catch-Up Contributions Tested?
Nondiscrimination
Testing. The actual deferral percentage (ADP) test determines
whether 401 (k) contributions discriminate in favor of highly
compensated employees. Catch-up contributions generally
do not count as pre-tax contributions when computing a participant's
deferral ratio under the ADP test. However, the plan must
retain what would have been a participant's refund of excess
contributions to the extent of that participant's remaining
catch-up limit, and these retained contributions are counted
when computing deferral rates under the ADP test.
Coverage
Testing. Generally, plans ignore catch-up contributions
when performing the average benefit percentage test under
Internal Revenue Code §410 (b) coverage rules.
Top-Heavy
Rules. Plans ignore catch-up contributions when determining
the contribution rate of a key employee under a top-heavy
plan (even if only catch-up contributions are allowed under
the plan), but catch-up contributions are included in plan
balances of key employees for purposes of determining whether
a plan is top-heavy.
Are
Catch-Up Contributions Matched? The new rules do not
prohibit a plan from matching catch-up contributions so
long as the match is counted in any applicable actual contribution
percentage (ACP) or ADP test. However, under the pre-2002
rules, a plan often must forfeit a matching contribution
on an elective deferral if some or all of the elective deferral
is refunded as an excess contribution under the ADP test,
or the plan will be disqualified because it provides a higher
matching rate only to highly compensated employees. The
new rules continue to apply this concept, so that matching
contributions on ADP test excess deferrals that are retained
in the plan as catch-ups may need to be forfeited.
Must
an Employer Allow Catch-Up Contributions in Every Plan?
If an employer's 401 (k) or 403 (b) plan allows catch-up
contributions, all of the employer's other plans allowing
elective deferrals (except 457 plans) must allow catch-up
eligible employees to contribute the same dollar amount
of catch-ups. However, a plan may limit a catch-up eligible
employee to that plan's contribution percentage limit plus
a pro rata portion of the catch-up limit. Also, plan sponsors
may delay implementing a catch-up contribution for a plan
acquired in connection with an acquisition or merger until
the amendment can practicably be made (but no later than
the end of the first plan year beginning after the merger
or acquisition).
What
Should be Done Now? Employers will find that implementing
a catch-up contribution program that satisfies the IRS,
eligible participants and the payroll department is surprisingly
complicated. Employers should evaluate now whether to allow
catch-up contributions and determine the administration
procedures the plan will employ. Although some of the compliance
burden will fall to the plan's third party vendor, most
of the early decisions to be made for the 2002 plan year
must be made by employers.
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For more information about the issues covered in this report, please contact David S. Foster in our San Francisco office at 415-369-7020 or at dsfoster@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2001 Thelen Reid Brown Raysman & Steiner LLP
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