IT'S ALL ABOUT MONEY

RETIREMENT PLANS--THE SOUNDS OF CHANGE

New law and tax regulations take effect
and additional legislation is being considered

William A. Clemmer & Gary S. Lesser, Esq.

If you listen carefully, you'll hear the sounds of change in retirement plan regulation from several directions. Some of this came with the passage of the new accounting law (courtesy of Enron). Others appear under the umbrella of tax simplification and some are called spousal rights protection.

Some of the provisions noted below were included in the accounting regulation, pushed through Congress on the heels of the accounting scandals and made retroactively effective as of January 27, 2002:

Plans must give plan participants advance notice of blackout periods (when such periods are four or more business days). "Blackouts" are where a plan can bar participants from changing their investment allocations, taking payments or allocations and making changes in their accounts for a specific period of time.

* Generally, plans must give notification at least 30 days in advance of any blackout. Notification must be in writing or by e-mail. A model notice is promised by the Department of Labor, perhaps by year-end.

* Violations are subject to heavy fines, which can be as much as $100 per day per participant.

* Executives get special notice. They cannot sell company stock acquired in connection with their employment during a blackout period.

Required distributions

Required distributions from plans and IRAs are generally lower as a result of new IRS regulations issued earlier this year. Retirement plan distributions must generally commence by April 1 after the year in which a participant turns 70 1/2. Business owners who own less than 5% of the company and who work beyond age 70 1/2 can defer the commencement of their distributions until they retire.

The IRS has revised the Life Expectancy Tables for the second time in two years. Congress mandated the change in the 2001 tax law by requiring the tables to reflect people living longer. The new tables allow longer distributions, which work out to be about an additional year. (See table below.)

IRA required distributions:

Calculation for 2002: Divide the sum of 2001 IRA year-end balances by the factor from the table.

Either the new table or prior table (and resulting larger distributions) can be used for calculations this year. Additionally, the following should be noted:

1. Those individuals with a spouse beneficiary who is more than 10 years younger also have a new, revised table, which reflects longer life expectancies. As above, the revision adds about one year to the joint life factors.

2. Pre-59 1/2 distributions without penalty can also be modified under the new tables. (The 10% premature distribution penalty is waived if withdrawals are taken as a series of substantially equal installments that continue for five years and until age 59 1/2.) If distributions were calculated using the prior table, a change to the new table does not constitute a prohibited modification.

3. IRA trustees may report whether distributions are required. This report may either be the amount to be withdrawn or be an offer to do the calculation. This requirement is effective for 2003 minimum distributions with reports due by January 31, 2003. This is applicable only to IRAs and not qualified plans. IRS reporting is not mandatory until 2004 for the 2003 Required Minimum Distribution (RMD). The IRS intends to alter Form 5498 to indicate that a RMD is due, probably adding a check box.

Along with tax simplification

Additional safeguards are included in a tax simplification bill (H.R. 5166--Rep. Rob Portman R-OH) that is said to have a good chance of passing, but which is currently taking a back seat to other legislation (like Homeland Security). Besides, tax relief looks better in an election year (2004). Some of the possible safeguards include:

1. Plan participants would not be required to invest solely in their employer's stock. (Why not just repeal ESOPs, which must invest primarily in employer securities?)

2. 401(k) plan participants would have the right to use alternative investments for deferrals and after-tax contributions to the plan. Participants with three or more years of service could not be required to invest in company stock for company matching or other contributions. This would apply for 2003 plan years.

3. Higher interest rate assumptions may be used for contributions to defined benefit plans. This would have the effect of reducing plan contributions.

4. Pension plan premiums (to the PBGC) for small plans would be reduced to $5 per participant (from $19 per participant) for the first five plan years.

5. Some school districts use supplemental (retirement) annuities as an early retirement incentive. The tax question is resolved by making these taxable when paid.

Several additional possibilities (still being discussed) are:

6. Increasing contribution limits

7. Moving the age for required distributions from plans and IRAs from 70 1/2 to 75.

8. The MAGI phase out of IRA contributions (and others, too) would be ended.

Spousal protection

The Senate is also considering the Women's Pension Protection Act of 2002 (S. 2707). As the title implies, provisions are aimed at the protection of spousal rights in retirement plans. Provisions still being fiercely debated are:

1. Spousal consent would be required for all defined contribution plan distributions other than loans, hardships, or rollovers to another qualified plan. (The consent would have to be in writing and notarized.)

2. Defined benefit plans would have to offer at least a 75% joint and survivor annuity, which we understand could be in lieu of the 50% joint and survivor annuity.

3. Former spouses would gain certain rights to a qualified plan spousal annuity if the participant has not remarried.

Many provisions of deep concern are likely to be excluded or limited to plans holding publicly traded stock. These would include the joint trusteeship of defined contribution plans and mandated fiduciary insurance for defined contribution plans. On the other hand, a number of important technical improvements have been added to several provisions in order to lessen their administrative burden. These would include:

1. Clarifications to the benefit statement provisions (either through legislative language or legislative history) to ensure that quarterly benefit statements are required only for participants with the right to direct investments.

2. That account values can be shown as of the most recent valuation date.

3. That vesting can be determined based on the most recent vesting computation period (i.e., vesting status does not have to be determined quarterly).

Education credits

Of note is a potential change of education credits. The Hope Credit (covering the first two years of college) and the Lifetime Earning Credit (for education after the first two years) would be combined. The new credit would be for 20% of up to $10,000 of tuition, books, and similar expenses for any level of college or post-graduate schooling.

As always, additions and changes are likely before final passage. However, the wind chimes are beginning to be heard on Capitol Hill. The final sounds of change will depend on whether and how Congress acts. *

The authors

William A. Clemmer and Gary S. Lesser, JD, head up Financial Services Agency Consulting (FSAC), a division of The Rough Notes Company. Clemmer has more than 25 years of financial services industry experience on Wall Street. Lesser writes and lectures widely on retirement planning and taxation issues. He is a member of the board of advisors for the Journal of Taxation of Employee Benefits.