Effective for calendar years beginning with 1997, the requirement that pension plans must commence distributions to participants who remain actively employed has been eliminated. The general rule now is that pension distributions must begin no later than April 1 of the year following the later of, (a) the calendar year in which the participant reaches age 70-1/2, or (b) the calendar year in which the participant retires. The new rule does not apply to 5% or more owners of the plan sponsor or to IRAs.
The IRS has announced that plans need not adopt the new rule. That is, plans may continue to require that benefits commence by the April 1 in the year after a participant attains age 70-1/2 even if that is before the participant's actual retirement.
If a plan sponsor wants to amend its plan to conform to the SBJPA change, however, the amendment may not be effective for participants who attain age 70-1/2 before 1999. Before 1999 participants may be given the option to commence payment of benefits or delay commencement of payments until actual retirement, or the plan may continue to require commencement of benefits regardless of retirement until its amendment becomes effective. Note also that a plan sponsor must amend its plan to conform to the SBJPA age 70-1/2 distribution rule within the remedial amendment period or be precluded from adopting the amendment thereafter.
The foregoing rules concerning the delayed effectiveness of the elimination of pre-retirement distributions apply to plans which do not otherwise permit in-service distributions. Pension plans generally may not permit in-service distributions (except for the mandatory age 70-1/2 rule), but profit sharing plans, including 401(k) plans, may permit in-service distributions. Thus, profit sharing plans which provide, or are amended to provide, for in-service distributions may eliminate the pre-retirement commencement of benefits at age 70-1/2 (except for 5% owners) immediately.
To recap: Pension plans may be amended to eliminate pre-retirement commencement of benefits (except for 5% owners), but only for participants who reach age 70-1/2 after December 31, 1998. In the meantime participants may, but are not required to, be given the option to delay commencement of benefits until retirement
Definition of Highly Compensated Employees (HCEs)
Effective for calendar years beginning with 1997 the definition of "highly compensated employee" has been simplified. An employee is an HCE if (a) the employee owns 5% or more of the plan sponsor in the current or previous plan year, or (b) the employee had compensation in the previous plan year exceeding $80,000 (and, if the plan sponsor elects, was in the top 20% of employees ranked by compensation). Plans must be administered in accordance with the new definition.
Effective for 1997 SBJPA also repealed the family aggregation rules (which were part of the definition of an HCE) which required that compensation and plan contributions to certain family members of HCEs be treated as paid to or on behalf of the HCE.
401(k) Plan ADP and ACP Testing
For plan years beginning in 1997 employers may determine the maximum elective contribution percentage and maximum matching contribution percentage for HCEs for the current year by reference to the average deferral and matching percentages of the non-highly compensated employees (NHCEs) for the prior plan year. These changes were in response to complaints by plan sponsors that they could not determine whether their plans passed the ADP and ACP tests until after the plan year ended.
Under the new rules plan sponsors may test the current year using the average deferral percentage for those employees who were NHCEs in the prior plan year whether or not those NHCEs are still employed or have become HCEs in the current year. Coupling this rule with the new definition of HCE which looks only to compensation in the prior plan year, means that plan sponsors can determine, in most cases, whether their plans meet the ADP and ACP tests on the first day of a plan year.
The new rules permit sponsors to continue testing using current year data if they so elect.
Plan sponsors should consider the testing options in light of their particular situations and in consultation with their plan advisors and administrators. For the periods before actually amending their plans sponsors should keep clear records of the testing methods used, so that they can demonstrate that those methods correspond to the plan amendments.
Distributions of Excess 401(k) Contributions
For plan years beginning in 1997 excess contributions by HCEs to 401(k) plans are attributed first to the HCE with the highest dollar amount of elective contributions. The former rule required return of excess contributions first to the HCE with the highest deferral percentage. The new rule is mandatory.
Section 415 Compensation
Effective for calendar years beginning with 1998 compensation used for determining maximum pensions under defined benefit plans and maximum allocations to accounts in defined contribution plans has been redefined to include employee elective deferrals to 401(k), 403(b) and 457 plans and elective contributions under cafeteria (Section 125) plans. Thus the limit on defined benefits of 100% of final average compensation and the limit on defined contribution annual allocations of 25% of compensation will be calculated on greater amounts of compensation than in the past.
Involuntary Cash-Outs
Effective for plan years beginning on or after August 6, 1997, a plan may pay lump sums to terminated participants without the participant's or spouse's consent if the present value of the benefit does not exceed $5,000. IRC 411(a)(11). The previous limit on involuntary cash-outs was $3,500.
Seizure of Benefits
Effective August 5, 1997, a plan may offset a participant's benefits when the participant has engaged in a crime involving the plan or has committed a breach of fiduciary duty to the plan, and a court orders the participant to pay a stated amount in restitution to the plan. The court's order may be entered as part of a criminal conviction, a civil judgment or pursuant to a settlement agreement with the Department of Labor or the Pension Benefit Guaranty Corporation.