ON JUNE 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "Tax Act"). Although the Tax Act provisions relating to the repeal of the federal estate tax have gained more notoriety, the provisions affecting retirement plans and retirement savings are also very significant.

The Tax Act has increased retirement savings opportunities while also simplifying the administration of retirement plans. These provisions should be of interest to lawyers as they evaluate their own retirement plans and saving for retirement. The Tax Act is generally effective Jan. 1, 2002, and also includes a "sunset provision," which provides that the entire Tax Act, including provisions affecting employee benefits, will expire after Dec. 31, 2010. This is unlikely to happen; based on the past history of employee benefits laws, we can expect these provisions to be amended before 2010.

The Tax Act substantially increases the Tax Code limits on the amount of compensation that may be considered for determining contributions to, or benefits from, tax-qualified retirement plans. For example, the dollar limit on annual elective deferrals to 401(k) plans and salary reduction SEPs has been increased from the current limit of $10,500 to $11,000 in 2002, and then in $1,000 increments until it reaches $15,000 in 2006, when it is slated to be indexed for inflation in $500 increments. The dollar limit on SIMPLE plan elective deferrals will similarly increase from $6,500 to $10,000 by 2005 and then will be indexed for inflation.

The Tax Act provides additional savings opportunities for individuals who are age 50 and above through elective deferral "catch-up contributions." These individuals will see the annual elective deferral limit under a 401(k) plan or SEP increased annually by $1,000 beginning in 2002 until the catch-up reaches $5,000 for 2006 and thereafter. The annual dollar limit for SIMPLE plans will be increased annually by $500 beginning in 2002 until the catch-up reaches $2,500 for 2006 and thereafter. The catch-up contributions will be indexed for inflation and are not subject to any other contribution limits and are not subject to the normal nondiscrimination rules.

The annual limit on the amount of compensation that can be considered for benefit purposes has been increased from $170,000 to $200,000 and will be increased for inflation in $5,000 increments. The annual total contribution limit for defined contribution plans such as 401(k) and profit sharing plans has been increased from the lesser of $35,000 or 25 percent of compensation to the lesser of $40,000 (indexed for inflation in $1,000 increments) or 100 percent of compensation. This will result in the opportunity for significant greater retirement savings for individuals in a position to target funds to retirement plans. In addition, the annual dollar limit on benefits payable from defined benefit pension plans has been increased from $140,000 to $160,000, and will be increased for inflation in $5,000 increments.

The Tax Act also makes subtle but potentially substantial changes to the deduction limit for employer contributions to profit-sharing plans. The monetary limit is increased from 15 percent to 25 percent of compensation and for purposes of calculating this limit compensation now includes amounts deferred pursuant to a salary reduction agreement. However, salary deferrals will not be treated as employer contributions and will not be counted against the deduction limit, as they were previously.

The Tax Act also increases the ability to save through IRAs. The contribution limit for education IRAs has been increased from $500 per child to $2,000. Funds can now be used for elementary and secondary, as well as post-secondary, education expenses. The annual contribution limit for traditional and Roth IRAs will be increased to $3,000 in 2002 and will gradually climb to $5,000 in 2008.

In addition to the increased savings opportunities, the Tax Act also makes a number of changes designed to ease the administration of retirement plans. For example, the Tax Act eliminates the restrictions on plan loans to owner-employees. Accordingly, sole proprietors, partners and owners of a subchapter S corporation may receive plan loans under the same rules as all other plan participants. In addition, the Tax Act has liberalized many of the restrictions on rollovers between plans and IRAs. Now eligible rollover distributions from qualified retirement plans, 403(b) annuities, governmental 457 plans and IRAs may now be rolled over to any of such plans or arrangements that accept the rollovers.

The Tax Act has accelerated the existing vesting requirements for employer matching contributions to a 401(k) plan. Starting in 2002, employer matching contributions must either (1) be 100 percent vested upon completion of three years of service (as opposed to five years under prior law), or (2) vest on a graded schedule at the rate of 20 percent per year beginning with the second year of service (as opposed to the third year under prior law). The prior vesting requirements remain applicable to all other employer contributions.

The distribution restrictions applicable to Section 401(k) plans have been changed to provide that distributions may occur upon a "severance from employment" rather than a "separation from service." This gives employers more flexibility in the mergers and acquisitions context by providing employees who continue to work at the same job with a successor employer the ability to roll over plan accounts to the plan of a new employer or to take a taxable distribution. Also in the mergers and acquisitions context, the Tax Act provides that a defined contribution plan to which benefits are transferred no longer needs to preserve certain optional forms of benefits if certain requirements are satisfied.

A notice requirement more expansive than Section 204(h) of ERISA has been added. It requires written notice to participants in a defined benefit plan or money purchase pension plan no less than 15 days prior to the effective date of an amendment significantly reducing future benefit accruals or resulting in any elimination or reduction of an early retirement benefit or retirement-type subsidy.

The above discussion touches on just a few of the many changes to tax-qualified retirement plans. Numerous other modifications have been made, including changes to the top-heavy, hardship withdrawal, funding and deduction rules for defined benefit plans. Employers will be required to make involuntary cash-out distributions to IRAs for accounts of $5,000 or less and will see reductions in fees and costs for adopting plans and tax incentives for providing retirement advice. Employers need to examine all of the changes and determine how best to take advantage of and implement them.

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