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Deadline for Amending Qualified Retirement Plans for EGTRA
The Economic Growth and Tax Relief Reconciliation Act of 2001
("EGTRRA"), which was enacted on June 7, 2001, included numerous
mandatory and optional modifications to the tax-qualified retirement
plan rules. Most of these changes are effective for years beginning
after December 31, 2001. While most of these changes are not
mandatory, a plan sponsor that chooses to implement an optional
provision of EGTRRA will have to amend a plan to conform the
provisions of EGTRA to the actual plan operation.
This memorandum is not intended to represent a comprehensive
discussion of the substantive provisions of EGTRRA. A checklist of
mandatory and optional EGTRA provisions for qualified retirement plans
is available at: http://www.groom.com/whatshot_updatelink_e.htm.
Plan Amendment Deadlines
IRS Notice 2001-42 provides a "remedial amendment period" ending no
earlier than the end of the 2005 plan year, during which a plan
sponsor may adopt any necessary retroactive plan amendments to enable
the plan to continue to satisfy the qualification requirements of the
Internal Revenue Code as a result of the changes made by EGTRRA. Thus,
like other recent changes in the law relating to tax-qualified
retirement plans (e.g., TRA '86 and GUST), the remedial amendment
period with respect to EGTRRA extends well beyond the effective date
of the changes, so long as the plan sponsor complied in operation
prior to such amendment.
Notice 2001-42 generally requires a plan to have a "good faith" EGTRRA
plan amendment in effect by the end of the plan year in which the
amendments are put into effect (generally, December 31, 2002 for
calendar year plans). Adoption of such a "good faith" amendment is
required in order for the plan sponsor to make retroactive plan
amendments to bring the plan into compliance with EGTRRA prior to the
end of the remedial amendment period. Once a plan sponsor adopts a
good faith EGTRRA amendment, it is then able to modify the provision
by a subsequent amendment to take into account guidance issued by the
IRS prior to the end of the 2005 plan year.
Recently, the IRS issued Notice 2001-57 which provides short sample
amendments that plan sponsors can adopt or use in order to implement
the basic provisions of EGTRRA for the 2002 plan year, thereby
qualifying for the IRS' "good faith" amendment standard. A copy of the
Notice can be obtained at:
http://ftp.fedworld.gov/pub/irs-drop/n-01-57.pdfq.
Despite the fact that the deadline for adopting a good faith EGTRRA
amendment is generally the last day of a plan year beginning in 2002
(e.g., December 31, 2002 for calendar year plans), plan sponsors must
take certain actions prior to such time. First, the plan sponsor's
board of directors (or other administrative body with the power to
amend the plan) must meet and decide which of the optional EGTRRA
provisions it wishes to adopt. With respect to increases in plan
limits that the plan sponsor chooses to adopt that affect participant
elections, plan sponsors will need to notify participants and update
election forms accordingly. Recordkeeping and payroll systems will
need to be modified as well.
So when does a plan "really" need to be amended for EGTRRA?
Although the IRS has stated that a plan generally does not need to be
amended for EGTRRA until the end of the plan's 2002 plan year (or if
later, by the end of the GUST remedial amendment period), the IRS also
stated that EGTRRA did not include any exceptions to the anti-cutback
rules of IRC Section 411(d)(6). Thus, if a plan is not updated until
the end of its 2002 plan year, then one must ensure that there are no
prohibited cutbacks or reductions of participant benefits.
In limited situations, a plan amendment adopted prior to the good
faith amendment deadline may be required to avoid a violation of the
Code's so-called "anti-cutback" rules. This could occur if an
amendment to a plan, after the start of the 2002 plan year, decreases
or eliminates benefits in effect under the terms of the plan at the
start of such year. In light of the uncertainty (given the absence of
current IRS or Treasury guidance) surrounding whether the adoption and
implementation of certain EGTRRA changes would constitute violations
of the anti-cutback rules, it may be beneficial for plan sponsors to
simply adopt good faith EGTRRA amendments before participants have
accrued the right to a benefit or allocation for the 2002 plan
year.
When have benefits accrued?
Unfortunately, there is very little IRS guidance on the subject of
when a benefit accrues and becomes protected by the anti-cut back
rules. A participant generally has accrued a benefit or allocation
once all conditions for sharing or receiving a contribution or benefit
have been satisfied. At that point, an amendment changing a benefit or
allocation formula retroactively would violate IRC Section
411(d)(6).
For example, suppose participants in a profit sharing plan are
eligible to share in an employer discretionary profit sharing
contribution if they have terminated employment with over 500 hours of
service. This type of plan provision means that once a participant has
over 500 hours of service, he or she will be eligible to share in any
profit sharing contribution that may be made to the plan for the year.
Consequently, the allocation formula under the plan could not be
changed, if the change will result in some participants receiving a
smaller share of the contribution. This is the case even though the
plan provides that no participant is entitled to any allocation until
the employer decides whether to make a contribution.
Alternatively, if a plan states that no participant is eligible to
share in an allocation unless the participant is employed at the end
of the plan year, then the allocation formula could be amended up
until the last day of the plan year. The reason is because no
participant would have earned the right to share in the contribution
until the last day of the plan year.
What does this have to with EGTRRA?
There are three general provisions of EGTRRA that are of concern due
to the anti-cutback rules.
The top-heavy provisions. EGTRRA made numerous changes to the
top-heavy rules (e.g., in determining top-heavy status, who are the
key-employees, and top-heavy minimums). It's possible that a plan that
had been top-heavy will no longer be top-heavy under the new
rules. However, a plan that has not been amended for EGTRRA provides
that if the plan is top-heavy under the old rules, non-key employees
are entitled to a minimum benefit. The issue is whether an amendment
made at the end of 2002 will result in a prohibited cutback of
benefits (non-key employees will not be entitled to the top-heavy
minimum if the plan is not top-heavy after the EGTRRA amendment is
taken into account).
For defined contribution plans, a participant is only entitled to the
top-heavy minimum if the participant is employed at the end of the
plan year. Therefore, the EGTRRA amendment changing the top-heavy
provisions can be made up to the day before the last day of the 2002
plan year.
For defined benefit plans, a participant is entitled to the top-heavy
minimum accrual if the participant has completed 1,000 hours of
service (assuming the plan is not using the elapsed time method of
crediting service). Therefore, the EGTRRA amendment changing the
top-heavy provisions can generally only be made prior to the time a
non-key participant is credited with 1,000 hours of service. However,
in Notice 2001-42 the IRS provided a limited exception to this
rule. Defined benefit plans may amend for EGTRRA by May 31, 2002 (or
March 31, 2002, if the plan uses the elapsed time method of crediting
service for accrual purposes) without violating the anti-cutback
rules.
The increased compensation limit to $200,000. If a plan is amended to
take into account the increase in the annual compensation limit to
$200,000, then, depending upon the plan, it's possible some
participants will receive a smaller share of any employer
contribution. For example, if a profit sharing plan allocates
contributions pro-rata based on compensation, then increasing the
amount of compensation taken into account for some participants will
reduce the share of the contribution allocated to the other
participants. As discussed above, if the amendment to increase the
compensation limit is made after some participants have earned the
right to share an employer's contribution under the original
allocation formula, then the informal IRS position is that the
amendment cannot be made for that year.
Faster vesting for matching contributions. Changing to a more liberal
vesting schedule (e.g., from a 7 year graded schedule to a 6 year
graded schedule) will reduce the amount of forfeitures to be allocated
for a year. Once again, if the above IRS reasoning is used, reducing
the amount of forfeitures to be allocated after a participant has
earned the right to share in those forfeitures could be construed as a
prohibited cutback of benefits.
What action should you take now?
Although final EGTRRA amendments are not required to be adopted before
the end of the 2005 plan year, the IRS is requiring all tax-qualified
retirement plans to adopt a "good faith" EGTRRA amendment by the end
of the 2002 plan year in order to make retroactive amendments relating
to EGTRRA. Despite this "deadline," a plan sponsor's board of
directors (or other administrative body with the power to amend the
plan) should decide which of the optional EGTRRA provisions it wishes
to adopt and on what terms it wishes to apply them. In addition to
making and implementing administrative decisions regarding EGTRRA, we
are also recommending that plan sponsors adopt good faith EGTRRA
amendments before participants have accrued the right to a benefit for
the 2002 plan year.
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