Pension Simplification Effective Dates

The Pension Simplification Act was passed as part of the minimum wage increases (PL 104-188). The key changes are summarized below by effective date.

Effective immediately

Repeal $5,000 death benefit exclusion. Until now, the first $5,000 of death benefits paid from a qualified retirement plan were excluded from the gross income of beneficiaries. This will no longer be the case.

10% tax on prohibited transactions. Prior to pension simplification, the tax on prohibited transactions was 5%. Plan sponsors have even more incentive to make certain their plans are funded and operated under ERISA rules.

Effective for 1997 plan years

Age 70 ½ distribution requirement is liberalized. Distributions must begin by April 1st following the year the employee turns age 70 ½ or, if later, retires. Only 5% owners must begin receiving their distributions by April 1 following the year they reach age 70 ½. This will be a significant simplification in administering qualified retirement plans. The age 70 ½ distribution rules were particularly cumbersome and awkward for defined benefit pension plans because benefits for participants working past age 70 ½ had to be recalculated every year.

Family aggregation rules eliminated. This will be a considerable simplification (particularly in the 401(k) plan tests and the $150,000 compensation limit) for employers that employ more than one family member.

Simplified definition of “Highly Compensated” employee. The new definition includes only 5% owners or employees earning over $80,000 (indexed to the Consumer Price Index and based on prior year's compensation.)

Tax exempt organizations are allowed to sponsor 401(k) programs. Tax-exempt organizations that were excluded from sponsoring 401(k) programs may now offer these plans to their employees.

Waive the excise tax on excess distributions for 1997, 1998, and 1999.

Employees have been subject to a 15% excise tax on distributions from a qualified retirement plan in excess of certain limits ($145,000 per year for annuities and installment payments.) This excise tax is eliminated if distributions are taken during the 3-year period. This is a decision of the individual and may be in important in estate planning.

Eased minimum participation rules. The minimum participation rules for defined contribution plans are eliminated which may allow certain employers to sponsor separate plans for certain groups of employees. The prior limit which still applies to defined benefit plans was that plans must cover at least 40% of the employees or 50 employees.

More lenient rules for benefits discrimination testing of 401(k) plans (ADP/ACP test).

The limit for highly compensated employees may be based on the contribution levels for the prior year. This lets the plan sponsor establish the limit for highly compensated employees at the early part of a plan year rather than after the end of the year.

When excess deferrals or contributions must be refunded after the end of the year, the refunds can now be based on dollar amounts rather than percentages of pay. Correcting a discrimination test in the past is required reducing contributions for highly compensated employees starting with the employees contributing the highest percentage of compensation. The result could be that employees at the lower end of the highly compensated spectrum might be affected more than employees at the higher end. Employers will be able to correct their ADP and ACP test by reducing the maximum dollar amount contributed by a highly compensated person until the tests are met.

Allow Simplified Incentive Match Plans Employers with 100 or fewer employees who provide no other qualified employer-sponsored retirement plan may establish a simple savings plan and not be subject to the ADP/ACP discrimination test.

The simple plans may be either IRA arrangements (simple retirement accounts) or 401(k) plans. Under either arrangement the employee pre-tax deferrals are limited to $6,000 per year (indexed.) The employer contribution must be 100% of the first 3% of pay contributed or alternatively 2% of pay for all eligible employees. Immediate vesting is required.

There are certain differences between the IRA and 401(k) versions of the simple plans which employers should consider before selecting the retirement arrangement for their plan.

The so-called SARSEPs (401(k)-like version of a Simplified Employee Plan) are eliminated and replaced by the SIMPLE plans starting in 1997.

Effective for 1998 plan years

Change in definition of compensation. Employee contributions to 401(k) plans and 457 government deferred compensation plans will include the employee contributions to these plans in compensation when determining an employee's maximum contribution and benefit amounts. Some employees will be able to contribute more than under the prior definition.

Effective for 1999 plan years

Safe harbor 401(k) plan eliminates testing. By making a minimum safe harbor employer contribution a plan sponsor can avoid the ADP/ACP test. An employer must match at least 100% of the first 3% of employee pretax deferrals and 50% of the next 2% of employee deferrals. Alternatively, the employer can make a 3% contribution to all eligible nonhighly compensated employees including those not making 401(k) deferrals. Note that although these provisions have some similarity to the SIMPLE plans, the employer contributions required under a SIMPLE plan are lower. SIMPLE plans are only available to employers with no more than 100 employees who sponsor no other retirement plan.

Effective for the plan year 2000

Eliminate 5 and 10-year averaging on lump-sum distributions. Lump-sum averaging will no longer be available for employees receiving distributions after December 31, 1999. There are no grandfather provisions.

Plan amendments

Some of the changes will require amendments to existing qualified retirement plans. The deadline for adopting the amendments is the first day of the plan year beginning on or after January 1, 1998. For a calendar year plan, this means amendments must be adopted by December 31, 1997. Provisions that have earlier effective dates must be administered as part of the plan even before the amendment is adopted.

If you have questions or comments, please contact us at Dean & Company.