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Employee Benefits Bulletin December 2001Catch-Up Contributions...How They WorkOf the employee benefit provisions in the new Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), catch-up contributions are drawing the most interest from plan sponsors. If adopted by the plan, certain participants may begin to take advantage of these contributions next year. But what are catch-up contributions and how do they work? On the most basic level, catch-up contributions are additional pre-tax deferrals, over and above current ERISA and plan deferral limits, that may be made each year by participants age 50 or older. Plans are not required to provide for catch-up contributions, even if the plan allows participants to make “regular” elective deferrals during the course of the plan year. How-ever, if an employer makes catch-up contributions available under one of its qualified plans, then all qualified plans of the employer (including plans of companies within the employer’s controlled group) that permit elective deferrals must offer catch-up contributions to eligible participants. Additionally, once an employer provides for catch-up contributions in a plan, all eligible participants must be allowed the effective opportunity to make the same dollar amount of catch-up contribution deferrals. In 401(k) plans, 403(b) plans, governmental 457 plans, and simplified employee plans (“SEPs”), catch-up contributions may be made by eligible participants in the following amounts: A plan participant is eligible to make catch-up contributions if he or she is over age 50 and is otherwise eligible to make deferrals under the plan. A participant is considered “over age 50” for a plan year if he is or will be 50 by the end of the calendar year, regardless of whether the participant dies or retires before his 50th birthday. So, now we know who may make catch-up contributions and, on a basic level, what catchup contributions are. On a more technical level, participant deferrals are not catch-up contributions unless, under normal circumstances, the participant would no longer be eligible to make further deferrals into the plan. There are three ways in which a participant may be prevented from making further deferrals: Statutory limitations are the ERISA guidelines set by Congress and the IRS, e.g., the 402(g) deferral limit of $10,500 (which will be increased to $11,000 in the 2002 plan year). Plan limitations are those internal limitations set by the plan on contributions or benefits given or received by participants (e.g., a 15% of compensation limit on deferrals). Finally, nondiscrimination testing may limit the amount certain highly compensated participants may contribute to the plan. For example, in 401(k) plans, a failed Actual Deferral Percentage (“ADP”) Test might require the plan to refund deferrals made by a highly compensated participant, even if that participant has not surpassed the plan limit or the 402(g) $11,000 deferral limit. Catch-up contributions are deferral amounts in excess of the first of these limitations applying to restrict a participant’s plan deferrals, i.e., the “applicable limit.” For example, a plan has a 15% of compensation deferral limit in 2002. Participant A (age 50) has compensation of $100,000 in 2002 and defers $11,500 over the course of the plan year. Assuming the plan passes its nondiscrimination testing so that nondiscrimination limits are not a factor, Participant A has made $500 of catch-up contribution deferrals. Although Participant A did not exceed the plan deferral limit of 15% of compensation ($15,000), the 402(g) limit of $11,000 (the “applicable limit” in this case) prevented him from making any further “regular” deferrals. The excess $500 is within the catch-up contribution limit for 2002 ($1,000), and therefore that $500 is a catch-up contribution. Generally, plan sponsors may look back at the end of the year to determine which deferrals are “regular” deferrals and which are actually catch-up contributions. Once the catch-up contributions have been identified, those contributions are disregarded for several purposes, including calculation of the 402(g) $11,000 limit on deferrals, the 415 limit on annual additions ($40,000 in 2002), and the ADP nondiscrimination testing ratios. Employers are not required (although it is permissible) to match the catch-up contributions, even if the plan matches the “regular” deferrals. Although the catch-up contribution deferrals themselves are exempt from nondiscrimination testing, if the employer decides to match the catch-up contributions, the match is subject to the Actual Contribution Percentage (“ACP”) Test and the $40,000 section 415 limit. For 2002, employers are required to report participants’ elective deferrals on Form W-2 in box 12 using Codes D through H and S. Employers should report employees’ qualified catch-up contributions in the totals reported for Codes D through H and S (IRS Announcement 2001-93). Special rules apply for participants in multiple plans and non-calendar year plans. More information may be found in the newly proposed IRS regulations on the subject.
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