Review Tax Changes to Maximize Employee Benefit Plans
In light of changing legislation, commercial real estate companies should review their employee benefits plans. The Economic Growth and Tax Relief Reconciliation Act of 2001 contained numerous changes to fundamental retirement plan rules for small businesses. Effective for plan years after Dec. 31, 2001 , these changes provide incentives for small businesses to establish new employee retirement plans and maximize savings opportunities by increasing contribution and deduction limits for retirement plans and individual retirement accounts and allowing for catch-up contributions.
Incentives for Establishing New PlansEGTRRA provides a tax credit for small businesses that adopt new qualified defined benefits or contribution plans with costs paid or incurred in taxable years beginning after Dec. 31, 2001 . The credit is equal to 50 percent of the qualified startup costs paid or incurred by the taxpayer during the taxable year. The dollar limitation with respect to the credit is $500 for each of the first three years of the plan; certain restrictions apply to this tax credit provision.
Defined Contribution Plan ChangesThe compensation limit that may be considered under a qualified plan increases from $170,000 to $200,000 and is indexed in $5,000 increments. The increase allows highly compensated employees to contribute more to their qualified plans.
It also is important to address the impact of this change on an employer's non-qualified plans. Non-qualified plans should be reviewed and, if necessary, amended to ensure that they reflect the new compensation limit. For example, if a non-qualified plan currently provides benefits for employee income above $170,000, then highly compensated employees will receive benefits for pay between $170,000 and $200,000 from both the qualified and non-qualified plans, unless the non-qualified plan is amended to incorporate the new pay limit of $200,000.
The dollar limit on annual additions to a defined contribution plan increases from $35,000 to $40,000, indexed in $1,000 increments. In addition, the related compensation limit for annual additions increases from 25 percent of compensation to 100 percent of compensation, which allows for increased contribution amounts for lower-compensated employees. This change could affect non-discrimination testing results significantly. Non-discrimination rules ensure that the average salary percentage contributed by highly compensated employees is not excessive when compared with contributions made on behalf of lower-compensated employees.
The dollar limit on annual elective deferrals to 401(k) plans, 403(b) annuities, and salary reduction simplified employee pensions increases to $11,000 this year. From 2003 to 2006, the limits are increased in $1,000 annual increments, with indexing in $500 increments thereafter. The maximum annual elective deferral that can be made to a savings incentive match or simple plan increases to $7,000 this year. In 2003, the simple plan deferral limit increases in $1,000 annual increments until 2005. Thereafter, the $10,000 dollar limit is indexed in $500 increments.
Elective deferral amounts may be increased for individuals who are age 50 or over by the end of the applicable year. These additional contributions allow individuals to catch up on their savings as they near retirement. Catch-up contributions can be made regardless of the past amounts a participant has contributed to his or her defined contribution plan and are not subject to non-discrimination testing. However, note that allowing for catch-up contributions requires the amendment of the plan document.
Enhanced Deduction Limits for Retirement PlansThis year, the annual limit on the amount of deductible contributions to profit-sharing, stock-bonus, or SEP plans increases from 15 percent to 25 percent of employees' compensation. In addition, except as provided in regulations, a money-purchase pension plan is treated like a profit-sharing or stock-bonus plan for purposes of the deduction rules. This change eliminates the need for a separate money-purchase plan to maximize deductions. For this reason, many companies are either merging or terminating their money-purchase plans to reduce administrative costs.
Under current law, employee elective deferrals to a 401(k) plan are treated as employer contributions and are subject to the generally applicable deduction limits. For years beginning after Dec. 31, 2001 , elective deferral contributions will not be subject to the deduction limits, thus permitting employers to increase their deductible contributions.
IRA ContributionsThe maximum annual dollar limits for IRA contributions increases incrementally through 2008. The schedule is $3,000 by 2004, $4,000 by 2007, and $5,000 by 2008. After 2008, the limit is adjusted annually in $500 increments. Individuals who are at least 50 years old may make additional catch-up IRA contributions.
Qualified Plan LoansGenerally, loans from qualified plans to owner-employees are prohibited. Effective for years beginning after Dec. 31, 2001 , loans from qualified plans to sole proprietors, 10 percent or more partners, or 5 percent or more S-corporation shareholders are exempt from this prohibition. However, loans from qualified plans to IRA owners are still prohibited.
Implementing the Changes
EGTRRA requires companies to make many design and administration changes to their retirement plans. Although most benefit plans are unique, companies can take the following general steps to ensure a smooth transition when converting a plan:
- ensure payroll systems are programmed with updated limitation amounts;
- communicate with participants and service providers regarding the implementation of new procedures and limitations;
- consider merging or terminating money-purchase pension plans;
- evaluate company benefit and retirement programs to provide the most cost-effective retirement savings plans for senior management;
- update election and enrollment forms; and
- revise plan documents, summary plan descriptions, distribution forms, rollover forms, and other materials.
The changes discussed represent only a small portion of EGTRRA provisions. While the EGTRRA provisions are set to expire for years beginning after Dec. 31, 2010 , consult a tax professional to review the effects of this sunset provision on your company's benefits program.