Tax-Sheltered Annuities and the Economic Growth and Tax Relief Reconciliation Act


As you may know, President Bush recently signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (referred to herein as the “Act”). The Act has changed many of the rules and limitations for tax-sheltered annuities.  This Client Alert briefly summarizes the changes made by the Act to the laws affecting tax sheltered annuities. These changes are scheduled to expire and will not apply to tax, plan, or limitation years beginning after December 31, 2010.  This sunset provision coupled with the increased contribution limits may result in contributions in excess of the limitations for 2011 when the old limits are reinstated due to the cumulative nature of certain limits.
Elective Deferral and Contribution Limits for 403(b)
The Act made the following changes to the contribution limits generally effective for years beginning after December 31, 2001:

  • The Act increased the basic elective deferral dollar limit applicable to any arrangement or plan subject to Section 403(b) of the Internal Revenue Code of 1986, as amended (“Code”). The current limit of $10,500 is increased in 2002 to $11,000 and is increased in $1,000 increments each year thereafter until 2006 when the limit reaches $15,000.  Thereafter, this limit is indexed for inflation in $500 increments.
  • For individuals who are at least age 50 by the end of a plan year, the Act has increased the elective deferral, beginning in the 2002 tax year, by an additional $500 each year until 2006 when it reaches $2,500.
  • Prior to the Act, the annual contribution limit for a tax-sheltered annuity was the lesser of the exclusion allowance or the Code Section 415(c) defined contribution annual addition limit.  For 2000 and subsequent years, 403(b) plans do not include defined benefit plan benefit accruals in the amount previously excluded in calculating the maximum exclusion allowance.  Beginning in 2002, the maximum exclusion allowance limit is no longer in effect until the Act sunsets after 2010.

The Act also made the following modifications to the rules regarding plan distributions:

  • For a 403(b) arrangement or plan that permits hardship distributions, the Act changes the 12-month wait on elective deferrals or after-tax contributions to a six-month period.  Effective for plan years beginning after December 31, 2001, the Act shortens this twelve-month period to six months.
  • Prior to the Act, the “same desk rule” prevented an employee from receiving a distribution from a plan if the employee continued in the same job for a different employer following the liquidation, merger, or consolidation of the former employer or outsourcing of a department, because the employee was not deemed to have “separated from service.”   However, the Act repealed the “same desk rule” and provides that employees who participate in a plan of an employer may receive a distribution after December 31, 2001 from the plan in the event they terminate employment.
  • Under the current law, a participant in a governmental plan cannot transfer amounts from a 403(b) arrangement or plan to a defined benefit governmental plan to purchase permissive service credits or repay a prior cashout from the governmental plan without including the amount in his or her gross income. Effective for years beginning after December 31, 2001, the Act removes this impediment and permits a participant to make a trustee-to-trustee transfer of amounts under a 403(b) annuity without including the amount in gross income, if the transfer is made for the purpose of (1) purchasing permissive service credits or (2) repaying contributions and earnings with respect to a previous forfeiture of service credit.

Tax Exempt Employers with 401(k) Plans and 403(b) Plans
The Act has directed the IRS to modify the nondiscrimination regulations to provide that employees of tax-exempt organization who are eligible to make contributions to a tax-sheltered annuity may be treated as excludable with respect to a cash or deferred arrangement under Code Section 401(k) or 401(m) if no employees of the tax-exempt organization are eligible to participate in the 401(k) or 401(m) arrangement and if 95 percent of the employees who are not employees of the tax-exempt organization are eligible to participate in the 401(k) or 401(m) arrangement.  These modified regulations shall apply for tax years beginning after December 31, 1996.
New Relief for Church and Certain Governmental Plans
Notice 2001-46 provides additional relief from the application of the nondiscrimination rules for church and certain governmental plans until further notice and provides these will not be effective earlier than the first plan year beginning on or after January 1, 2003.
If you have any questions about the Economic Growth and Tax Relief Reconciliation Act of 2001, please contact one of the authors listed at the top of the page.

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