IRS Permits Retroactive Application of Certain EGTRRA Provisions; Issues Sample Plan Amendments

IRS Notice 2001-56 provides important guidance on effective dates for certain provisions in the Economic Growth and Tax Relief Reconciliation Act, while companion Notice 2001-57 provides model plan amendments to simplify the EGTRRA amendment process for employers.

$200,000 Pay Cap
EGTRRA amended §401(a)(17) by increasing the $150,000 pay cap (as adjusted in recent years for cost of living increases) to $200,000, effective for plan years beginning after December 31, 2001. The notice clarified that plans may apply the higher cap retroactively for purposes of determining benefits as a percentage of pay in 2002. Participants whose benefits were limited by the old pay cap must satisfy the plan’s conditions for benefit accrual in 2002 in order to realize increased benefits due to retroactive application of the new pay cap.

For plans that base benefits on final average pay, applying the higher pay cap retroactively primarily benefits employees who terminate or retire soon after the effective date of the increase. Affected employees who continue working for the final averaging period for plan compensation, usually three or five years, will realize the full increase without retroactive application. This issue apparently affected the IRS decision allowing retroactive application. Future cost of living adjustments to the $200,000 limit may not be applied retroactively.

To apply the new limit retroactively, employers must adopt a plan amendment.

Safe Harbor Hardship Distributions
EGTRRA shortened the deferral suspension period for employees who take hardship distributions from their 401(k) plan. Previously set at one year, employees now may resume elective deferrals six months after taking the hardship distribution. Under the new notice, the shorter wait period becomes effective for calendar years beginning after December 31, 2001, rather than for hardship distributions taken after December 31, 2001, permitting more employees to take advantage of the new law. For example, employers may amend their plan so that an employee who receives a hardship distribution in 2001 has to wait only six months after the distribution to resume elective deferrals (or until January 1, 2001, if later).

Alternatively, plans may retain their 12-month suspension period for all hardship distributions (or for all hardship distributions before January 1, 2002), unless they use Code §401(k)(12) and 401(m)(11) design-based safe harbors to satisfy the ADP or ACP test. These plans must reduce the suspension period from 12 to six months, effective January 1, 2002, or instead, for all hardship distributions after December 31, 2001.

Sample Plan Amendments
The IRS has also issued model plan amendments to simplify the EGTRRA amendment process for employers. Their early release was important because plan terms must reflect actual plan operations for this round of legislative changes, and some EGTRRA amendments must be in place by the end of the first plan year beginning in 2002, or even earlier. A plan sponsor that adopts “good faith” EGTRRA amendments has until the end of the 2005 plan year to revisit EGTRRA and make remedial amendments, subject to ERISA’s anti-cutback rule.

Model EGTRRA amendments will be considered good-faith amendments, but their use is not mandatory. Individualized amendments that indicate reasonable efforts were made to take EGTRRA requirements into account should also satisfy the good-faith standard.

The IRS intends to wrap up the current GUST determination letter program before it begins to consider EGTRRA plan amendments. So individualized amendments that satisfy the EGTRRA good-faith standard will not be eligible for determination letter reliance for a while.