Prop. Regs. Issued on Age 50 "Catch-Up" Deferrals for Sec. 401(k), 403(b) and Other Plans

T he IRS issued proposed regulations on Oct. 23, 2001, explaining retirement plan "catch-up" contributions made by individuals age 50 and over as provided in Sec. 414(v) (added by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)). In general, the proposed regulations apply to catch-up contributions in tax years beginning in 2002.

Plans Eligible to Offer Catch-Up Contributions

The following types of employer-sponsored plans are the primary vehicles to which catch-up contributions may apply:

• Sec. 401(k) plans;
• Sec. 403(b) annuity plans;
• Sec. 457 eligible governmental plans;
• Savings incentive match plan for employees (SIMPLE) IRA plans; and
• Simplified employee pension (SEP) plans.

Age 50 Requirement

Only participants age 50 or over may make catch-up contributions. A participant projected to reach age 50 before the end of a calendar year is deemed to be age 50 as of January 1 of such year.

Determination of Catch-Up Contributions

Elective deferrals that exceed any "applicable limit" are treated as catch-up contributions to the extent they do not exceed the catch-up contribution dollar limit.

Applicable limits. Catch-up contributions are determined by reference to three types of plan limits:

1. A statutory limit is a ceiling on elective deferrals or annual additions imposed under Sec. 401(a)(30), 415, 457 or 403(b)(1)(E), among other provisions.

2. An employer-provided limit is a limit on elective deferrals provided under the plan terms but not required under the Code.

3. The average deferral (ADP) limit is the highest dollar amount of elective deferrals that a highly compensated employee (HCE) may retain in the plan under Sec. 401(k)(8)(C).

Catch-up contribution limits. The annual catch-up contribution limits will be phased in over the next five years:

The annual limit for SIMPLE IRAs is $500 for 2002, $1,000 for 2003, $1,500 for 2004, $2,000 for 2005 and $2,500 for 2006. After 2006, the annual limit for catch-up contributions will be adjusted for inflation in $500 increments.

Timing. In general, the amount of elective deferrals in excess of an applicable limit is determined as of the end of the plan year, by comparing the total elective deferrals for the plan year with the applicable limit for the plan year. For an applicable limit determined on the basis of a year other than the plan year, the determination of whether elective deferrals exceed the applicable limit is made on the basis of such other year.

Treatment of catch-up contributions for ADP, top-heavy and minimum coverage testing. In calculating a catch-up for an eligible participant's actual deferral ratio for ADP testing purposes, elective deferrals for a plan year treated as catch-up contributions because they exceed a statutory limit or an employer-provided limit are disregarded. If a plan needs to take corrective action under Sec. 401(k)(8) to pass ADP testing, the plan must then determine the amount of elective deferrals to be treated as catch-up contributions. The plan must retain excess elective deferrals treated as catch-up contributions.

Current-year catch-up contributions are not taken into account for Sec. 416 or 410(b) purposes. However, catch-up contributions made in prior years are taken into account in determining whether a plan is top-heavy under Sec. 416 and for purposes of the average benefit test under Sec. 410(b)(2) (to the extent prior-years' contributions are taken into account).

Universal Availability Requirement

A plan that offers catch-up contributions must provide all catch-up-eligible participants with the "effective opportunity" to make the same dollar amount of catch-up contributions. If one plan of an employer that permits elective deferrals offers catch-up contributions, all such plans of that employer must also do so.

Plan Sponsors with Multiple Plans

For purposes of determining whether elective deferrals exceed a "statutory limit" (in which the excess is treated as a catch-up contribution), all of a participant's elective deferrals under all applicable employer plans are aggregated in the same manner as elective deferrals are aggregated in applying the underlying limit. In addition, the aggregate amount of elective deferrals treated as catch-up contributions because they exceed the statutory limit must not exceed the applicable dollar catch-up limit for the tax year.

Further, if an HCE is a participant in more than one of an employer's Sec. 401(k) plans, in determining whether the employee's elective deferrals exceed an employer-provided limit, the employer-provided limit for the plan year is the sum of the dollar amounts of the limits under the separate plans. In addition, the employee's elective deferrals under all of the employer's Sec. 401(k) plans must be combined.

Application of Sec. 402(g) Deferral Ceiling

Generally, catch-up contributions will not be treated as exceeding the employee-deferral limits of Sec. 402(g) ($11,000 in 2002). A catch-up-eligible participant whose elective deferrals under two or more employers' plans exceed the participant's Sec. 402(g) dollar limit may treat the elective deferrals in excess of the limit as catch-up contributions (up to the maximum amount of catch-up contributions permitted for the tax year), even though the elective deferrals do not exceed an applicable limit under either plan.

From Seth Tievsky, Washington, DC