IRS Issues Final Regulations for Catch-Up Contributions
July 28, 2003
On July 7, 2003, the Internal Revenue Service issued final regulations on catch-up contributions under Section 414(v) of the Internal Revenue Code (IRC). In general, a retirement plan participant can make catch-up contributions if the participant turns age 50 during the calendar year and makes elective deferrals in excess of plan and statutory limits. The IRC limits catch-up contributions to $2,000 in 2003, but this limit increases annually by $1,000 until 2006.
Beginning January 1, 2004, the final regulations for catch-up contributions apply to 401(k) plans, SIMPLE IRA plans, simplified employees pension plans, tax-sheltered annuity contracts or plans and eligible governmental plans (eligible plans). Of special note, the final regulations modify the universal availability requirements for collectively bargained plans and provide additional guidance for plans with non-calendar plan years.
Determination of Catch-up Contributions
The final regulations clarify that catch-up contributions under eligible plans are treated as elective deferrals under the IRC and remain subject to the same vesting and distribution rules as other elective deferrals. Under the final regulations, catch-up contributions continue to be exempt from other statutory requirements, such as contribution limits and the actual deferral percentage test. The final regulations also clarify that a plan may forfeit any matching contributions on elective deferrals that are reclassified as catch-up contributions.
Like the proposed regulations, the final regulations continue to prohibit an eligible plan from determining catch-up contributions on a payroll-by-payroll basis. Given this restriction, eligible plans generally can calculate the permitted maximum catch-up contribution for a plan participant only following the end of the plan year. The final regulations provide only one exception to this general rule of plan year-end calculation: an elective deferral in excess of statutory contribution limits ($12,000 for 401(k) plans in 2003) can be determined when the contribution is made.
Universal Availability Requirement
Under the universal availability requirement, catch-up contributions must be offered under all eligible plans sponsored by members of the same controlled group of companies. The final regulations create an exception to the universal availability requirement for collectively bargained employees. Generally, employees covered by a collective bargaining agreement that includes retirement provisions need not be given the opportunity to make catch-up contributions.
The final regulations also provide a transition period under the universal availability requirement for eligible plans within a controlled group following a corporate acquisition or disposition. The final regulations no longer require that such plans be amended as soon as administratively practicable to comply with the universal availability requirement. The final regulations provide that a plan that satisfied the universal availability requirement prior to the corporate acquisition or disposition will continue to satisfy this requirement during a transition period following the transaction. The transition period begins on the date the controlled group changed and runs through the end of the plan year following the plan year in which such change occurred.
Participants in Multiple Controlled Group Plans
The final regulations continue to apply special coordination rules to a participant who participates in more than one eligible plan within a controlled group during the same calendar year. This situation often arises when an employee is transferred among controlled group members that sponsor different eligible plans. If an eligible plan participant participates in more than one controlled group plan during the same calendar year, then the participant may make catch-up contributions only under the second plan up to the catch-up limit that remains after subtracting catch-up contributions under the first plan. Either eligible plan can determine which elective deferrals are treated as catch-up contributions if the manner of determination is consistent with the way the elective deferrals were actually made.
Non-Calendar Year Plans
The final regulations describe how catch-up contribution limits and other statutory limits interact in non-calendar year plans. In general, calculating catch-up contributions in a calendar year plan is straightforward because all statutory limits generally apply on a calendar year basis. In a non-calendar year plan, however, the coordination of statutory limits is more complicated. For non-calendar year plans, the final regulations make it clear that catch-up contributions made within the calendar year are excluded in determining statutory contribution limits. To comply with this rule, non-calendar year plans will need to retain accurate records on the exact date all contributions are made.
For example, suppose the plan year of a 401(k) plan runs from November 1 to October 31. Between November 1 and December 31, 2002, a participant who is over age 50 makes $1,000 in elective deferrals. The participant does not exceed the statutory contribution limit for calendar 2002 and does not make any catch-up contributions. Between January 1, 2003 and October 31, 2003, the participant makes $13,000 in elective deferrals. Thus, the participant has made $14,000 in elective deferrals during the plan year. Because $13,000 in elective deferrals exceeds the statutory contribution limit for calendar 2003, the plan automatically re-classifies $1,000 as a catch-up contribution ($13,000 of elective deferrals in 2003 minus $12,000 statutory contribution limit in 2003). Thus, the participant cannot make any additional elective deferrals in calendar 2003 but can make $1,000 in additional catch-up contributions between November 1 and December 31, 2003, ($2,000 catch-up contribution limit in 2003 minus $1,000 catch-up contribution in calendar 2003).
In light of the final regulations, employers that implemented catch-up contributions should have their eligible plan and procedures reviewed for compliance. In most cases, employers that adopted catch-up contributions simply followed prior IRS model amendment language that did not specify all the applicable rules. Now that final regulations have been issued, employers should consider amending plan language and modifying plan procedures. On the other hand, those employers who have not yet adopted catch-up contributions may now wish to reconsider that decision in light of the final IRS guidance.
