Retirement Plan Limit Changes

Defined Benefit Plan Distribution Limits

Prior Law
The maximum annual benefit payable from defined benefit plans is limited to the lesser of:

100% of average compensation for the highest three years, or
$140,000 for 2001 (then indexed for inflation in $5,000 increments).

The maximum annual benefit payable is reduced for individuals who retire before the social security retirement age.

The maximum annual benefit payable is increased for individuals who retire after social security retirement age.

Annual payments from certain statutorily described collectively bargained defined benefit plans are limited to the greater of:

$68,212, or
50% of the current defined benefit plan dollar limit.

New Law
The maximum annual benefit payable from defined benefit plans is increased to the lesser of:

100% of average compensation for the highest three years, or
$160,000 for 2001 (then indexed for inflation in $5,000 increments).

The maximum annual dollar limit is reduced for individuals who retire before age 62.

KPMG Observation

This change permits individuals to retire before reaching social security retirement age and receive their full unreduced plan benefit.

The maximum annual dollar limit is increased for individuals who retire after age 65.

Annual payments from certain statutorily described collectively bargained defined benefit plans are limited to 50% of the current defined benefit plan dollar limit.

Effective Date
Effective for years ending after 2001.

Modifications to Section 415 Limits for Multiemployer Plans

Prior Law
Under a defined benefit plan, maximum annual payments, starting at retirement, are generally the lesser of:

100% of average compensation for the highest three years, or
$140,000 for 2001 (then indexed for inflation in $5,000 increments.

In applying limits on contributions and benefits, plans of the same employer are added together.

New Law
The 100%-of-compensation portion of the defined benefit plan limit does not apply to multiemployer plans.

Multiemployer plans are plans for employees covered by collective bargaining agreements. Multiemployer plans are not aggregated with single-employer defined benefit plans maintained by an employer contributing to the multiemployer plans for purposes of applying the 100%-of-compensation limit to the single-employer plans.

Effective Date
Effective for years beginning after 2001.

Defined Contribution Plan Contribution Limits

Prior Law
The total of employer plus employee annual contributions to defined contribution section 401(a) plans and section 403(b) arrangements is limited for each participant to the lesser of:

25% of compensation, or
$35,000 for 2001 (then indexed for inflation in $1,000 increments).

New Law
The annual contribution limit for employer plus employee contributions to defined contribution section 401(a) plans and section 403(b) arrangements is increased to the lesser of:

100% of compensation, or
$40,000 for 2002 (then indexed for inflation in $1,000 increments).

Effective Date
Effective for years beginning after 2001.

Designated Roth Contributions

Prior Law
An individual may make employee elective contributions of up to $10,500 to a section 401(k) plan or section 403(b) arrangement. The contributions are not included in current income, and the earnings on the contributions are tax-deferred. Upon distribution, these contributions plus earnings are included in gross income. In addition, an employee may be permitted to make after-tax employee contributions to a plan (these contributions have already been included in current income). As with employee elective contributions, the earnings on after-tax contributions are tax-deferred until distribution. Upon distribution, the portion attributable to the after-tax contributions is not taxed again, but the earnings are taxed.

New Law
An employee can designate all or part of an employee elective contribution (up to the employee elective contribution limit) to a section 401(k) plan or section 403(b) arrangement as a "designated Roth contribution." Designated Roth contributions are not excludible from income. If the rules are followed, the earnings on designated Roth contributions are completely tax-free upon distribution.

The section 401(k) vesting and nondiscrimination rules and the section 401(k) distribution restrictions apply to designated Roth contributions.

Plans must establish separate "designated Roth accounts" and maintain separate records for designated Roth contributions.

For distributions to be tax-free, a special five-year holding rule applies, and distributions must be made after age 59½, disability, or death of the participant. A designated Roth account may be rolled over only to another designated Roth account or to a Roth IRA.

KPMG Observation

Designated Roth accounts offer a phenomenal benefit, as they allow significant savings to build within an employer plan with the chance of being completely tax-free at retirement.

Example

Phillip contributes $5,000 per year to a plan from age 25 to age 30. He identifies these contributions as designated Roth contributions and pays tax on them. He is just out of school, and his tax bracket is fairly low. Even if Phillip never makes another contribution, his $30,000 of savings could grow significantly by the time he is 65. The distribution from his designated Roth account at age 65 will be completely tax-free.

KPMG Observation

Interestingly, the Roth IRA rule permitting a limited distribution to purchase a new house has not been brought into the designated Roth contribution rule. This may be because a participant can take a loan from an employer-sponsored retirement plan, unlike from an IRA or Roth IRA.

Effective Date
Effective for tax years beginning after 2005.

Compensation Limit

Prior Law
Section 401(a) plans, section 403(b) arrangements, simplified employee pensions (SEPs), and certain voluntary employees' beneficiary associations (VEBAs) must ignore any compensation above $170,000 when determining contribution or benefit limits. The compensation limit is indexed for inflation in $10,000 increments.

New Law
The compensation limit for section 401(a) plans, section 403(b) arrangements, simplified employee pensions (SEPs), and certain VEBAs is increased to $200,000, indexed for inflation in $5,000 increments.

Effective Date
Effective for years beginning after 2001.

Employee Elective Contribution Limits

Prior Law
Contributions under a salary reduction agreement are often referred to as "elective contributions" or "employee elective contributions." The maximum annual employee elective contribution to a section 401(k) plan, section 403(b) arrangement, or a SEP is $10,500. The maximum annual employee elective contribution to a SIMPLE plan is $6,500. These limits are indexed for inflation in $500 increments.

New Law
The dollar limit on annual employee elective contributions for section 401(k) plans, section 403(b) arrangements, and salary reduction SEPs is increased to:

$11,000 in 2002
$12,000 in 2003
$13,000 in 2004
$14,000 in 2005
$15,000 in 2006 (then indexed for inflation in $500 increments).

The maximum annual employee elective contribution limit for SIMPLE plans is increased to:

$7,000 in 2002
$8,000 in 2003
$9,000 in 2004
$10,000 in 2005 (then indexed for inflation in $500 increments).

KPMG Observation

When fully phased in, this increase in the limits will allow participants to save considerably more for retirement.

Effective Date
Effective for years beginning after 2001.

Special Catch-Up Contributions for Individuals Over Age 50

Prior Law
For 2001, the maximum annual employee elective contribution to a section 401(k) plan or section 403(b) arrangement is $10,500 and to SIMPLE plan is $6,500.

There is a special catch-up rule for certain participants in section 403(b) arrangements who have at least 15 years of service with their current employer.

New Law
A plan can permit individuals who are at least age 50 by the end of the taxable year to make additional catch-up employee elective contributions. The catch-up contributions are limited to no more than the lesser of the:

"Applicable dollar amount", or
Participant's compensation for the year reduced by any of the participant's other employee elective contributions for the year.

The "applicable dollar amount" for section 401(k) plans and section 403(b) arrangements is:

$1,000 in 2002
$2,000 in 2003
$3,000 in 2004
$4,000 in 2005
$5,000 in 2006 (then indexed for inflation in $500 increments).

Catch-up contributions are not subject to any other contribution limits and are not counted when applying other contribution limits. Catch-up contributions are not subject to nondiscrimination rules, as long as all eligible participants are allowed to make the same election. Employers can match catch-up contributions, subject to the normal discrimination rules.

The "applicable dollar amount" for SIMPLEs under sections 401(k)(11) and 408(p) is:

$500 in 2002
$1,000 in 2003
$1,500 in 2004
$2,000 in 2005
$2,500 in 2006 (then indexed for inflation in $500 increments).

The over age 50 catch-up contribution is in addition to the special section 403(b) arrangement rule for employees with more than 15 years of service.

KPMG Observation

This change allows participants to catch up on contributions that they did not make in prior years because, for example, they had other expenses, did not earn as much, or left work to care for a family member. This change also allows participants to save more as they near retirement. Example: Employee A is a highly compensated employee who is over 50 and who participates in a section 401(a) plan sponsored by A's employer. The maximum annual deferral limit (without regard to this provision) is $15,000. After application of the special nondiscrimination rules applicable to section 401(k) plans, the maximum annual elective deferral A may make for the year is $8,000. Under the provision, A is able to make an additional catch-up salary reduction contribution of $5,000.

Effective Date
Effective for contributions in tax years beginning after 2001.

Shorter Contribution Restrictions Following Hardship Distributions

Prior Law
Elective employee contributions (plus earnings) may be distributed if the participant suffers a "hardship." In most plans, an employee cannot make employee elective contributions or after-tax contributions for at least 12 months after receiving a hardship distribution. This rule is intended to encourage participants to increase take-home pay as much as possible following a hardship distribution.

New Law
The 12-month suspension is reduced to six months. Hardship distributions are not "eligible rollover distributions."

Effective Date
Effective for years and distributions beginning after 2001.

Deduction Limit Changes

Prior Law

Employer contributions to one or more section 401(a) plans are deductible subject to certain limits. Each deduction limit depends on the type of plan.
The annual limit on deductible contributions to a profit sharing or stock bonus plan is 15% of the aggregate compensation of the employees covered by the plan for the year. The definition of compensation for this 15%-of-compensation limit does not include employee elective contributions.
For purposes of the deduction limit, however, employee elective contributions to a section 401(k) plan are treated as employer contributions and are subject to the deduction limits.

New Law

Employee elective contributions are not subject to the deduction limits. Thus, in determining the maximum annual deduction limitation for contributions to a qualified retirement plan, the employer does not count employee elective contributions.
The annual limit on the amount of deductible contributions to a profit sharing, stock bonus plan, or money purchase pension plan is limited to 25% of compensation of the employees covered by the plan for the year.
The definition of compensation for purposes of the deduction rules includes employee elective contributions. Thus, the compensation on which the deduction is based is larger than under prior law.

KPMG Observation

These changes may encourage employers to make profit-sharing contributions and eliminate plan-designed contribution limits. Previously, generous section 401(k) plans ran into the 15% limit because of the employee elective contributions.

Effective Date
Effective for years beginning after 2001.