SUMMARY OF RETIREMENT SAVINGS PROVISIONS INCLUDED IN H.R. 1102, AS PASSED BY THE HOUSE OF REPRESENTATIVES ON JULY 19, 2000

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1 SUMMARY OF RETIREMENT SAVINGS PROVISIONS INCLUDED IN H.R. 1102, AS PASSED BY THE HOUSE OF REPRESENTATIVES ON JULY 19, 2000 Issue Current Law H.R IRA MODIFICATIONS IRA Contribution Limits Catch-Up Contributions The maximum total annual new contribution permitted to IRAs (including traditional deductible IRAs, Roth IRAs and nondeductible IRAs) is the lesser of $2,000 or 100% of the individual s compensation. Starting in 1997, the limit for married couples was generally increased to the lesser of $4,000 ($2,000 per spouse) or the couple s combined compensation. The maximum IRA contribution has been set at $2,000 since If the IRA contribution limit had been adjusted for inflation since IRAs were created in 1974, Americans could now contribute approximately $5,000 per year. Generally, individuals who do not actively participate in an employment-based retirement plan are eligible to contribute to an IRA. For all other individuals, eligibility is based on statutory income limits. In 2000, eligibility to contribute to a deductible IRA is phased-out for single taxpayers with income between $32,000 and $42,000 and for joint filers with income between $52,000 and $62,000. Eligibility to contribute to a Roth IRA is phased-out between $150,000-$160,000 for joint returns and $95,000- $110,000 for individuals. Roth IRA eligibility is unrelated to participation in an employment-based plan. Once an individual has missed the opportunity to make an IRA contribution for a given year, the individual has no opportunity to catch-up in later years. The contribution limit for all IRAs would be increased to $5,000. In 2001, the IRA contribution limit would be $3,000. In 2002, the IRA contribution limit would be $4,000. In 2003, the IRA contribution limit would be $5,000. After 2003, the IRA contribution limit would be indexed for inflation annually. [Note: The 100% of compensation limitation would continue to apply.] Revenue Cost: $9.733 billion (5 years). Taxpayers age 50 and over would be permitted to contribute up to $5,000 to an IRA in 2001 and 2002, i.e., no phase-in would apply to these individuals. Revenue Cost: $616 million (5 years). GENERAL LIMITS ON RETIREMENT PLAN CONTRIBUTIONS AND BENEFITS Defined Contribution Plan Limit (Section 415(c)) Defined Benefit Plan Limit (Section 415(b)) Section 415(c) currently limits maximum annual contributions to defined contribution plans on behalf of an individual to the lesser of 25% of compensation or $30,000. The $30,000 limit is indexed for inflation in $5,000 increments. In 1982, the limit of section 415(c) was $45,475. The current $30,000 limit has been in place since [Section references herein are to the Internal Revenue Code of 1986, as amended, unless otherwise indicated.] Section 415(b) limits maximum annual benefits under a defined benefit plan to the lesser of 100% of three-year-high-average pay or $135,000 (in 2000). In 1982, the dollar limit of section 415(b) was $136,425. Actuarial reduction of the section 415(b) limit is required for benefit commencement prior to Social Security retirement age (generally between age 65 and 67). This means, for example, that a 55-year old employee retiring in 1999 at age 55 would have a section 415(b) limit of $55,000. Prior to the Tax Reform Act of 1986 (1986 Act), actuarial reductions were only applicable if benefits commenced prior to age 62 and actuarial The $30,000 dollar limit in section 415(c) would be increased to $40,000. Future indexing of this limit would be in $1,000 increments. Revenue Cost: $63 million (5 years). [The 25% of compensation limit is modified separately. See description below.] The $130,000 dollar limit in section 415(b) would be increased to $160,000. Actuarial reduction of the section 415(b) dollar limit would be required only for benefit commencement prior to age 62. Provisions regarding actuarial reductions for state and local government plans, multiemployer plans and plans maintained by tax-exempt organizations would be repealed. Revenue Cost: $182 million (5 years) for increase to $160,000; $21 million (5 years) for Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP

2 reductions could not reduce the limit below $75,000 at age 55. These pre-1986 Act rules have continued to apply to State and local government plans, plans maintained by tax-exempt organizations and qualified merchant marine plans. For this purpose, the definition of a plan maintained by a tax-exempt organization has been unclear. retirement age changes. [The 100% of compensation element of section 415(b) for multiemployer plans is modified separately. See description below.] Maximum Salary Reduction Contribution (Section 402(g)) Section 457(b) Plan Contribution Limit SIMPLE Plan Contribution Limit Compensation Taken Into Account (Section 401(a)(17)) Repeal of Coordination Requirements for Section 457(b) Plans In the case of an individual that has not participated in any defined contribution plan of the employer, a minimum benefit of $10,000 may generally be paid without regard to the compensation limit of section 415(b). Section 402(g) limits elective deferrals under most salary reduction plans, (e.g., section 401(k) plans and section 403(b) arrangements) to $10,500 (in 2000). Prior to the 1986 Act, there was no special limit on elective deferrals. The dollar limit on contributions under eligible deferred compensation plans under section 457(b) is generally $8,000 in 2000 [or $15,000 (not indexed) in the three years prior to normal retirement age]. In 1979, the limit on deferred compensation plans was set at $7,500. Until 1998, it was not indexed for inflation. Maximum elective deferrals to SIMPLE retirement plans are limited to $6,000 per year, indexed for inflation in $500 increments. Section 401(a)(17) limits compensation that may be taken into account in determining benefits under qualified plans to $170,000 (in 2000), indexed in $10,000 increments. In 1993, the limit under 401(a)(17) was $235,840. Prior to the 1986 Act, the limit generally only applied to top-heavy plans and SEPs. The deferred compensation that may be provided to an employee by a State or local government or a tax-exempt employer is generally limited to $8,000 (in 2000) by section 457(b). This limit is generally reduced by elective deferrals under other types of arrangements and by section 403(b) contributions. In addition, deferred compensation under a section 457(b) plan is taken into account in applying a special catch-up rule for section 403(b) arrangements. The limit on elective deferrals to plans governed by section 402(g) (including section 401(k) plans and 403(b) arrangements) would be increased to $15,000 (on a phased-in basis). The limit would be increased to $11,000 in 2001; $12,000 in 2002; $13,000 in 2003; $14,000 in 2004; and $15,000 in Thereafter, indexing would occur as under current law. Revenue Cost: $2.958 billion (5 years). The limit on elective deferrals to eligible deferred compensation plans under section 457(b) would be increased to $11,000 in 2001; $12,000 in 2002; $13,000 in 2003; $14,000 in 2004; and $15,000 in The limit would be twice the otherwise applicable limit in the three years prior to retirement. Thereafter, indexing would occur in $500 increments, as under current law. Revenue Cost: $628 million (5 years). The limit on elective deferrals to SIMPLE plans would be increased to $7,000 in 2001; $8,000 in 2002; $9,000 in 2003; and $10,000 in 2004 (with indexing thereafter as under current law). Revenue Cost: $106 million (5 years). The section 401(a)(17) compensation limit would be increased to $200,000 (with indexing in $5,000 increments). Revenue Cost: $391 million (5 years). The section 457(b) limit on deferred compensation would not be reduced by elective deferrals under other types of arrangements or by section 403(b) contributions. In addition, deferred compensation under a section 457(b) plan would not be taken into account for purposes of the section 403(b) catch-up rule. [Note the dollar limit on section 457(b) plan contributions is increased to $15,000 by Section 1201.] Revenue Cost: $104 million (5 years). Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -2-

3 ENHANCING FAIRNESS FOR WOMEN AND CHILDREN Additional Salary Reduction Catch-up Contributions Increase Percentage of Salary Limitations Faster Vesting of Employer Matching Contributions Simplify and Update the Minimum Distribution Rules The Code imposes annual limits on the maximum amount that can be contributed by an employee to a section 401(k) plan, a section 403(b) arrangement, a SIMPLE plan, and certain other salary reduction arrangements. With certain limited exceptions, once an individual has missed the opportunity to make a contribution for a given year, the individual has no opportunity to catch-up in later years. Under section 415(c), total annual additions to defined contribution plans-- including both employer and employee contributions--for any employee are limited to the lesser of $30,000 or 25% of compensation. Section 403(b) arrangements are subject to the section 415(c) limits and to a complex limit--the maximum exclusion allowance (MEA)--that can limit contributions to 20% of compensation times years of service minus previous contributions. Generally, under section 457(b), total contributions to an eligible deferred compensation plan are limited to 33a% of compensation. Employee salary reduction contributions are immediately vested. Employer contributions to most retirement plans either must be fully vested after the employee has completed five years of service, or must become vested in increments of 20% for each year beginning with the employee s third year of service, with full vesting after the employee has completed seven years of service. In general, section 401(a)(9) and related provisions require certain minimum distributions from retirement plans and IRAs starting at the later of age 70½ or retirement (except that deferral until retirement is not permitted with respect to IRAs and 5% owners). These minimum distributions must generally be completed over the lives or life expectancies of the individual and his or her beneficiary. In the event the individual dies before all assets are distributed, different required distribution rules may apply depending on whether the individual has attained age 70½. The IRS proposed regulations with respect to section 401(a)(9) were published in They have never been finalized. Failure to comply with the section 401(a)(9) minimum distribution rules results in the imposition of a 50% excise tax on the amount not distributed. Individuals who are age 50 or older would be allowed to make an additional, annual $5,000 catch-up contribution to a 401(k) plan, section 403(b) arrangement, SIMPLE plan (other than salary reduction only SIMPLE plans). These additional contributions would not be subject to any other contribution limits, but would be subject to the generally applicable nondiscrimination rules. An employer would be permitted to make matching contributions with respect to catch-up contributions, but any such matching contributions would be subject to normally applicable rules. Revenue Cost: $286 million (5 years). The section 415(c) 25% of compensation limitation would be increased to 100%. The MEA limit would be repealed (thus generally subjecting section 403(b) arrangements to the new general 415(c) limit). The 33a% of compensation limit of section 457(b) would be increased to 100% of compensation. Revenue Cost: $401 million (5 years). Employer matching contributions under section 401(k) plans, section 403(b) arrangements, or other qualified plans would be required either to be fully vested after an employee has completed three years of service or to become vested in increments of 20% for each year beginning with the employee s second year of service, with full vesting after the employee has completed six years of service. Effective Date -- The changes would generally apply to contributions for plan years beginning after December 31, 2000, with an extended effective date for plans maintained pursuant to a collective bargaining agreement. The section 401(a)(9) rules would be updated and simplified as follows: The Secretary of the Treasury would be directed to rewrite and finalize the current proposed section 401(a)(9) regulations (and related regulations) in a manner that substantially simplifies the calculations and makes them fairer. In particular, such regulations would have to be modified (1) to reflect increases in life expectancy and (2) to revise the required distribution methods so that, under reasonable assumptions, the amount of the required distribution does not decrease over a participant s life expectancy. During the first year that such final regulations are in effect, required distributions for future years may be redetermined for future years to reflect changes under such regulations, including the opportunity to choose a new beneficiary and/or elect a new method of calculating life expectancy. Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -3-

4 The bill would simplify the minimum distribution rules by creating one uniform set of rules for beneficiaries, regardless of whether the employee dies before or after age 70½ (e.g., 5-year rule applies when participant dies after distributions have begun). The excise tax for failure to make a required minimum distribution under section 401(a)(9) would be reduced from 50% to 10%. Revenue Cost: $1.135 billion (5 years). Treatment of Section 457(b) Benefits Upon Divorce Reduction in Suspension From Pension Plan Due to Hardship Withdrawal An active employee s benefit under a qualified plan or a section 403(b) arrangement may be paid to a former spouse pursuant to a qualified domestic relations order without violating the otherwise applicable restrictions on in-service distributions. In addition, such distributions are taxable to the former spouse as the recipient. The rules described above do not apply to section 457(b) plans. In addition, it is unclear who is taxed on the 457(b) distribution, which has led to inconsistent practices and frustrated expectations. Treasury regulations provide that a participant who takes a hardship withdrawal from a pension plan is subject to a twelve-month suspension from the plan, meaning that the participant cannot make additional contributions. The provision would generally clarify the law regarding distributions from section 457(b) plans pursuant to qualified domestic relations orders by applying the same rules applicable to qualified plans and section 403(b) arrangements. Effective Date -- The changes would apply to transfers, distributions, and payments made after December 31, The Secretary of Treasury would be directed to revise the regulations so that the suspension period following a hardship withdrawal would be reduced from twelve months to six months. Effective Date The revised regulations would apply to years beginning after December 31, OTHER PROPOSALS TO EXPAND COVERAGE AND BENEFITS GENERALLY Deduction Limit for Stock Bonus and Profit Sharing Plans Elective Deferrals Not Taken Into Account for Purposes of Deduction Limits An employer s deduction for contributions to a profit-sharing or stock bonus plan is generally limited to 15% of the taxable compensation of the plan s participants. The limit on deductions to other types of plans is generally 25%. In addition, in applying the percentage of compensation limits on deductions, compensation does not include pretax contributions (e.g., retirement plan and cafeteria plan contributions). This rule differs from the definition of compensation that is applied for purposes of the section 415(c) limits and the section 401(a)(4) nondiscrimination rules, where it is permitted to count salary reduction contributions. Contributions made by an employer to one or more qualified plans are generally deductible by the employer subject to certain limits. For example, contributions to a section 401(k) plan (other than a SIMPLE 401(k) plan) are generally deductible to the extent that, in the aggregate, they do not exceed 15% of the total compensation of the employees in the plan. A 10% excise tax applies to nondeductible contributions. The annual limitation on the amount of deductible contributions to a profit-sharing or stock bonus plan would be increased from 15 percent to 20 percent of compensation of the employees covered by the plan for the year. In addition, the definition of compensation for purposes of the deduction rules would include salary reduction amounts treated as compensation under section 415. Revenue Cost: $47 million (5 years). Elective deferrals would not be subject to the deduction limits, nor would they be taken into account in applying deduction limits to other contributions. Revenue Cost: $396 million (5 years). Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -4-

5 Roth 401(k) and Roth 403(b) Plans ESOP Dividends May Be Reinvested Without Loss of Dividend Deductions Retirement arrangements under section 401(k) and 403(b) allow employees the choice of whether to make elective contributions of pay into a retirement plan or to take such amounts in cash. Amounts that are contributed to the plan under these elective deferral arrangements are generally not included in income until distributed from the plan (i.e., they receive a front-loaded tax incentive). Contributions to traditional deductible IRAs receive a similar front-loaded tax advantage, i.e., they are deductible from income in the year of the contribution. In the Taxpayer Relief Act of 1997 ( 1997 Act ), Congress created Roth IRAs as an alternative to the traditional IRA. As a general matter, Roth IRAs are subject to the same rules as traditional IRAs. However, with a Roth IRA there is no up-front tax deduction. Rather, the tax advantage is delayed or back-loaded since all retirement distributions are tax-free. Dividend deductions are allowed under section 404(k) on dividends paid on employer stock to an unleveraged ESOP only if the dividends are paid to employees in cash; the deduction is denied if the dividends remain in the ESOP for reinvestment. Would allow section 401(k) plans and 403(b) arrangements to add an after-tax PLUS program permitting participants in the plan to choose between making elective deferrals under the traditional "front-loaded" 401(k) program or under the new after-tax PLUS program. PLUS contributions would receive back-loaded tax incentives like those currently afforded Roth IRAs, i.e., there would be no immediate income tax exclusion, but all distributions from the account would be tax-free. If a worker leaves employment before retirement, distributions from the PLUS program could be rolled over to a Roth IRA instead of a traditional IRA. Unlike Roth IRAs, conversion of current 401(k) or 403(b) account balances into the PLUS program would not be permitted. In most other respects, PLUS contributions would be treated in the same manner as traditional front-loaded elective deferrals. For example, in applying the limit on total elective contributions contained in section 402(g) and nondiscrimination rules applicable to elective deferrals, traditional front-loaded contributions and PLUS contributions would be counted. Similarly, limits on in-service distributions generally applicable to elective deferrals would also be applicable to PLUS contributions and matching contributions could be available on the same terms regardless of whether the individual makes traditional front-loaded contributions or PLUS contributions. The tax treatment of matching contributions would not be changed and employees could choose to invest their PLUS contributions from among the same investment options now available in the 401(k). The provision would increase revenues by $514 million (5 years). An employer would be allowed to deduct dividends paid to an ESOP when its employees are allowed to elect to take the dividends in cash or leave them in the plan for reinvestment in employer stock. Revenue Cost: $243 million (5 years). PROPOSALS TARGETED PRIMARILY AT SMALL BUSINESSES Top-Heavy Rules Section 416 establishes complicated testing rules for determining whether or not a plan is top-heavy (e.g., whether key employees are deemed to be receiving an excessive proportion of the plan benefits). The term key employee generally includes officers earning over half of the section 415 defined benefit plan dollar limit (i.e., $65,000 in 1998), 5% owners, 1% owners earning over $150,000, and the 10 employees with the largest ownership interests in the employer (as long as they earn more than $30,000). Generally, the top-heavy rules affect only plans maintained by small businesses. Top-heavy plans are required to satisfy a special vesting schedule and make minimum contributions or accruals for non-key employees. Plans which are super top-heavy must make additional minimum contributions or accruals and are subject to a lower aggregate limitation under section 415(e). The law also requires that the top-heavy provisions be included in all plans, even those which can never become top-heavy. The top heavy rules would be amended as follows: The family aggregation rule repeal (included in the Small Business Job Protection Act of 1996) would be extended to family aggregation under the top-heavy rules. The definition of key employee would be modified to delete both the four-year look back rule and the top-10 owner rule and to provide that an employee will not be treated as a key employee based on his or her officer status unless the employee earns more than $150,000 (the same compensation figure applicable to 1% owners). Matching contributions on behalf of employees would count toward satisfying the topheavy minimum contribution requirements. Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -5-

6 [When a defined benefit plan that is top-heavy is frozen, there is a requirement that non-key employees still earn a benefit.] In determining whether a plan is top-heavy, all benefits from all years of service are generally taken into account. Other than in the case of in-service distributions, the look-back rules would be shortened from 5 years to 1 year, so that, in applying the top-heavy rules, it would not be necessary to take into account 5-year old information regarding distributions and employees. Plans meeting the section 401(k) and section 401(m) safe harbors would be exempted from the top-heavy rules. Plan Loans for Self-employed User Fee Reductions Reporting Simplification A qualified retirement plan or section 403(b) arrangement is permitted to make loans to participants. However, the statutory exemption from the Code and ERISA prohibited transaction rules for participant loans generally does not apply to business owners if the business is unincorporated (i.e., partnerships and sole-proprietorships) or has made an election to be taxed under the provisions of subchapter S. All businesses must pay a user fee to the IRS in order to obtain a determination letter (or other IRS guidance) that their plan is tax-qualified. The general fee for obtaining a determination letter regarding a plan s qualified status can range from $700 to $1,250 or more, depending on the nature of the request and the type of plan. One-participant retirement plans are exempt from the annual report filing requirement for a plan year if they did not hold more than $100,000 in total plan assets at the end of that plan year or any preceding plan year beginning on or after January 1, A one-participant plan that is not exempt from the annual report filing requirement is only required to file a simplified form, i.e., Form 5500-EZ. A oneparticipant plan is a plan that covers and benefits only certain owners (or such owners and their spouses) of the sponsoring employer and meets the following requirements: The plan satisfies the section 410(b) coverage requirements without being aggregated with any other plan. The plan does not cover a business that is a member of an affiliated service group, a controlled group of employers, or a group of businesses under common control. The plan does not cover a business that leases employees. If a defined benefit plan is frozen so that no key employees are earning a benefit, there would not be a requirement that non-key employees earn a minimum benefit. Revenue Cost: $50 million (5 years). The prohibited transaction rules would be amended to provide equal access to participant loans for all employees, including the owners of small businesses that are unincorporated or choose to be taxed under subchapter S. Effective Date -- The changes would take effect for loans made after December 31, Revenue Cost: $153 million (5 years). Small businesses (100 or fewer employees) would not be required to pay a user fee with respect to any determination letter (or other request) relating to the qualification of a retirement plan. The elimination of the user fee would not apply to requests made by sponsors of prototype plans which the sponsor intends to market to employers or to requests made after the first five years of the plan. Effective Date -- The changes would apply to requests made after December 31, Revenue Cost: $19 million (5 years). A one-participant retirement plan with assets of $250,000 or less as of the close of the plan year would be exempt from the annual report filing requirement for that plan year. A plan that covers fewer than 25 employees on the first day of the plan year would only be required to file a Form 5500-EZ, provided that the plan meets the three requirements with respect to the definition of a one-participant plan. Effective Date -- The changes would take effect on January 1, Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -6-

7 INCREASING PORTABILITY FOR PARTICIPANTS Rollovers Among Various Types of Employment- Based Retirement Plans Rollovers From Contributory IRAs To Qualified Plans An eligible rollover distribution from a 401 or 403(a) plan may be either: (1) rolled over by the distributee into an eligible retirement plan within 60 days of the distribution; or (2) directly rolled over by the distributing plan to an eligible retirement plan. An eligible retirement plan is another section 401 plan, a section 403(a) plan or an IRA. Amounts transferred from a 401 plan or a 403(a) plan to a so-called conduit IRA may later be rolled back into another 401(a) or 403(a) plan, if they are kept segregated from other IRA assets. In the case of section 403(b) arrangements, distributions which would be eligible rollover distributions except for the fact that they are distributed from a section 403(b) arrangement may be rolled over to another section 403(b) arrangement or an IRA. Amounts transferred from a 403(b) plan to a conduit IRA may later be rolled back into another 403(b) plan, if they are kept segregated. Under these rules, for example, amounts distributed from a section 403(b) arrangement may not be rolled over to a section 401(k) plan or vice versa. When an eligible rollover distribution is made, the plan must provide a written notice to the distributee explaining the availability of a direct rollover to another plan or an IRA, that failure to exercise that option will result in 20% being withheld from the distribution, and that amounts not directly rolled over may be rolled over within 60 days. In the case of a section 457(b) deferred compensation plan, distributions may not be rolled over by a distributee; however, amounts may be transferred from one section 457(b) plan to another section 457(b) plan without giving rise to income to the plan participant. A participant in a section 457(b) plan is taxed on plan benefits that are not transferred when such benefits are paid or when they are made available. In contrast, a participant in a qualified plan or a section 403(b) arrangement is only taxed on plan benefits that are actually distributed. Also, a section 457(b) plan is required to meet minimum distribution requirements in addition to those of section 401(a)(9). With the exception of conduit IRAs, rollover of amounts originally contributed directly into an IRA ( contributory IRAs ) into any type of employment-based plan is not allowed. Eligible rollover distributions from a section 401 plan could be rolled over to another section 401 plan, a section 403(a) plan, a section 403(b) arrangement, a section 457(b) deferred compensation plan maintained by a state or local government or an IRA. Likewise, eligible rollover distributions from a section 403(b) arrangement could be rolled over to the same broad array of plans and IRAs. With respect to section 457(b) deferred compensation plans, only eligible rollover distributions from plans maintained by a state or local government could be rolled over to the same broad array of plans and IRAs. In the case of section 457(b) plans, eligible rollover distributions would include hardship distributions. The mandatory 20% withholding would apply to the section 457(b) plan. Distributions from a state or local government section 457(b) plan attributable to a rollover from a plan (other than a 457(b) plan) would be subject to the section 72(t) 10% tax on premature distributions. For this purpose, the section 457(b) plan would be required to agree to separately account for amounts rolled over to the plan from other types of plans before such a rollover could be accepted. For section 457(b) plans maintained by a state or local government, amounts paid would be subject to the withholding rules applicable to other plans and IRAs; the wage withholding rules would not apply. The written notice required to be provided when an eligible rollover distribution is made would be expanded to include a description of restrictions and tax consequences which will be different if the plan to which amounts are transferred is a different type of plan from the distributing plan. Participants who mix amounts eligible for special capital gains and averaging treatment with amounts which are not so eligible would lose such treatment. Surviving spouses who receive eligible rollover distributions could rollover those amounts to all types of plans, not just IRAs. A participant in a section 457(b) plan would be taxed on plan benefits that are not transferred or rolled over only when they are actually paid. Also, a section 457(b) plan would be required to only meet the section 401(a)(9) requirements with respect to minimum required distributions. Effective Date -- The changes would apply to distributions made after December 31, The provision would increase revenues by $5 million (5 years). Conduit IRAs would be eliminated. Instead, amounts in IRAs could be rolled over to a section 401(a) plan, a section 403(a) plan, a section 403(b) arrangement, a section 457(b) plan maintained by a state and local government, or another IRA. The same rule would apply to SIMPLE accounts except that amounts subject to the increased penalty tax could be rolled over only into another SIMPLE account. Participants who mix amounts eligible for special capital gains and averaging treatment with amounts which are not so eligible would lose such treatment. Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -7-

8 Effective Date The changes would apply to distributions made after December 31, Rollovers of After-Tax Contributions Rollovers Not Made Within 60 Days of Receipt Anti-Cutback Relief Same Desk Rule Repeal Employees are allowed to make after-tax contributions to IRAs, 401(k) and other plans. They are not permitted to roll over distributions of those after-tax contributions into an IRA or another plan. Rollovers from qualified plans to an IRA (or from an IRA to another IRA) must occur within 60 days of the initial distribution. Income tax withholding rules apply to certain distributions that are not direct trustee-to-trustee transfers from the qualified plan to an IRA. The section 411(d)(6) anti-cutback rule generally provides that when a participant s benefits are transferred from one plan to another, the transferee plan must preserve all forms of distribution that were available under the transferor plan. The anti-cutback rule also generally provides that, without regard to a transfer, a plan may not eliminate forms of distribution. Generally 401(k) plan distributions are limited to separation from service, death, disability, age 59½, hardship, plan termination, and certain corporate transactions. The term separation from service has been interpreted to include a same desk rule. Under the same desk rule, a distribution to a terminated employee is not generally allowed if the employee continues performing the same functions for a successor employer (such as a joint venture involving the former employer or the buyer in a business acquisition). The same desk rule also applies to section 403(b) and 457(b) arrangements (but does not apply to other types of plans, such as defined benefit plans). After-tax employee contributions could be rolled over to other plans and IRAs. Rollovers of after-tax amounts from one plan to another could only be a direct rollover. Plans (other than IRAs) accepting rollovers of after-tax amounts would be required to separately account for such amounts (and the earnings thereon). After-tax amounts could not be rolled over from IRAs. Effective Date -- The changes would generally apply to distributions made after December 31, The IRS is given the authority to extend the 60-day period where the failure to comply with such requirements is attributable to casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirements. Effective Date -- The hardship exception to the 60-day period would apply to distributions made after December 31, An employee would be able to consent to a transfer of benefits from one defined contribution plan to another defined contribution plan without requiring the transferee plan to preserve the optional forms of benefit under the transferor plan if certain requirements are satisfied to ensure the protection of participants interests. In addition, except to the extent provided in regulations, a form of distribution in a defined contribution plan could be eliminated with respect to a participant if (1) a single sum distribution is available to such participant at the same time or times as the form of distribution being eliminated, and (2) such single sum distribution is based on the same or greater portion of the participant's account as the form of distribution being eliminated. Treasury authority to waive section 411(d)(6) would be expanded, and Treasury would be directed to issue regulations before The same desk rule would be eliminated by replacing separation from service in section 401(k)(2)(B) with severance from employment. Conforming changes would be made in the comparable provisions applicable to section 403(b) arrangements and eligible deferred compensation plans under section 457(b). Effective Date -- The changes would apply to distributions after December 31, Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -8-

9 Purchase of Service Credit in Governmental Defined Benefit Plans Rollovers Disregarded For Purposes of Cash-out Rule Under State law, employees of State and local governments often have the option of purchasing service credits in their State defined benefit pension plans in order to make up for time spent in another State or district. These employees cannot currently use the money in section 403(b) arrangements or section 457(b) plans to purchase service credits. In applying the $5,000 cash-out rule, amounts that a plan accepts in a rollover from another plan or IRA are counted. State and local government employees would be able to use funds from their section 403(b) arrangements or section 457(b) plans to purchase service credits. Effective Date -- The changes would apply to distributions after December 31, In determining whether an employee s benefit level falls below the $5,000 cashout threshold, benefits that have been rolled over by the employee from another employer s plan or IRA would not be taken into account. Effective Date -- The changes would apply to distributions after December 31, STRENGTHENING PENSION SECURITY, EDUCATION AND ENFORCEMENT Repeal of 150% of Current Liability Funding Limit Contributions to a defined benefit plan are not deductible to the extent that plan assets exceed the lesser of (1) 150% of the plan s current liability, or (2) a limitation based on a reasonable projection of benefits. Pursuant to the Taxpayer Relief Act of 1997, the 150% figure will be phased up to 170% by the year For 2000, it is set at 155%. The 150%-of-current-liability component of the cap was enacted in OBRA 1987 primarily to raise revenue. Prior to the enactment of OBRA 1987, only the projected benefit limit applied. The full funding limit would be 160% of current liability for plan years beginning in 2001, 165% in 2002, 170% in 2003 and repealed in 2004 and after. Effective Date -- The changes would apply to plan years after December 31, Revenue Cost: $109 million (5 years). Maximum Contribution Deduction Rules Applied to All Defined Benefit Plans Penalty Tax Relief For Sound Pension Funding In the case of any defined benefit plan (other than a multiemployer plan) which has more than 100 participants, the employer may generally deduct any contribution necessary to increase plan assets to 100% of the plan s current liability. A 10% excise tax is generally imposed on employers making nondeductible contributions to qualified plans. Except as provided in regulations, the special deduction rule for plans with more than 100 participants would be modified so that it also applies to multiemployer plans and plans with 100 or fewer participants. In addition, deductible contributions would be permitted up to termination liability (instead of current liability). In the case of a plan with fewer than 100 participants, liabilities attributable to recent benefit increases for highly compensated employees would be disregarded. The change would not apply to plans established and maintained by professional service employers with fewer than 25 employees). Effective Date -- The changes would apply to plan years beginning after December 31, Revenue Cost: Cost included in estimate for repeal of 150% of current liability funding limit. The 10% excise tax on nondeductible contributions would generally not apply to any contributions to a defined benefit plan up to the full funding limit (determined without regard to the 150% of current liability component of the full funding limit). Revenue Cost: $14 million (5 years). Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -9-

10 Employer- Provided Retirement Education Notice of Significant Reduction in Benefit Accruals (Cash Balance Conversions) Prohibited Allocations of Stock in an ESOP of an S Corporation Employer-provided retirement advice is not generally considered income to the employee receiving such advice, although some uncertainty exists. Under ERISA section 204(h), a defined benefit plan or a money purchase pension plan may not be amended in a manner that results in a significant reduction in the rate of future benefit accrual unless, after the adoption of the plan amendment (and not less than 15 days before the effective date of the plan amendment), the plan administrator provides a written notice to affected participants and alternate payees. The ERISA section 204(h) notice must specify the plan amendment and its effective date. Alternatively, under the applicable regulations, the notice may contain a summary of the amendment, if the summary is written in a manner calculated to be understood by the average plan participant and contains the effective date. The summary need not explain how the individual benefit of each participant or alternate payee will be affected by the amendment. Qualified retirement plans may own stock in an S corporation. The income of an S corporation allocable to an ESOP is not subject to current taxation. Section 1042 provides a deferral of income on the sales of certain employer securities to an ESOP. A 50 percent excise tax is imposed on certain prohibited allocations of securities acquired by an ESOP in a transaction to which section 1042 applies. In addition, such allocations are currently includible in the gross income of the individual receiving the prohibited allocation. Employer-provided qualified retirement planning services would be excluded from income and wages. The exclusion would be intended to allow employers to provide advice and information (but not retirement planning services such as tax preparation or brokerage services), but would not apply with respect to highly compensated employees unless the services are available on substantially the same terms to each member of the group of employees normally provided education and information regarding the employer s retirement plan. A provision would be added to the Internal Revenue Code providing that a pension plan with more than 100 participants must provide participants with a written notice concerning a plan amendment that provides for a significant reduction in future benefit accruals under the plan. Such notice must describe the benefit reduction caused by the plan amendment in a manner calculated to be understood by the average plan participant. Except to the extent provided by Treasury regulations, the notice would have to be provided within a reasonable time period prior to the effective date of the plan amendment. The penalty for failure to comply with the notice requirements would equal $100 per day per omitted party with a maximum penalty of $500,000 in any year (except in cases of willful neglect). The Secretary of the Treasury could waive this penalty if reasonable cause for failure is shown. In addition, Treasury would be directed to prepare a report on the effects of conversions of traditional defined benefit plans to hybrid formula plans, including the effect of such conversions on longer service participants and the incidence and effect of wear away provisions. Effective Date -- The changes would apply to plan amendments taking effect after the dare of enactment. If there is a nonallocation year (i.e., any plan year of an ESOP holding shares in an S corporation if during the plan year substantial shareholders own at least 50 percent of the outstanding shares of the S corporation) with respect to an ESOP maintained by an S corporation, then (1) the amount generally allocated to such substantial owner would be treated as distributed to such individual; (2) an excise tax would be imposed on the S corporation equal to 50 percent of the amount involved; and (3) an excise tax would be imposed on the S corporation with respect to any synthetic equity owned by a disqualified person. Effective Date -- The changes would generally apply to plan years beginning after December 31, In the case of an ESOP established after July 11, 2000 or an ESOP established on or before such date if the employer maintaining the plan was not an S corporation on such date, the proposal would be effective with respect to plan years ending after July 11, The provision would increase revenues by $28 million (5 years). Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -10-

11 REDUCING REGULATORY BURDENS Repeal of the Multiple Use Test Safety Valve from Mechanical Rules Reform of the Line of Business Rules Coverage Test Flexibility Modification of Timing of Plan Valuations Under the so-called Actual Deferral Percentage (ADP) test, 401(k) contributions must generally satisfy either one of two rules: the 125% rule or the 2 percentage point/200% rule. The 2 percentage point/200% rule is the less restrictive rule at lower levels of contributions; at very high levels, the 125% rule is less restrictive. Under the so-called Average Contribution Percentage (ACP) test, matching contributions and after-tax employee contributions generally must satisfy one of the same two rules. In addition, the multiple use test prohibits a plan from fully using the 2 percentage point/200% rule with respect to both the ADP and ACP tests. Under a formula, it is permissible to use the 2 percentage point/200% rule partially with respect to each test. The nondiscrimination rules applicable to qualified plans and section 403(b) arrangements under section 401(a)(4) consist of a series of complicated mechanical tests. Prior to 1994, these rules were not mechanical but rather were applied based on all the facts and circumstances. Technically, an employer that wishes to test retirement plans on a Separate Line of Business basis may do so. However, the current Separate Line of Business rules impose draconian testing and employee allocation requirements that make them unworkable. Moreover, before using the Separate Line of Business test, the employer must pass a gateway test that applies on an employer-wide basis, thus defeating the purpose of the Separate Line of Business rules. The section 410(b) coverage rules applicable to qualified plans and section 403(b) arrangements consist of a series of complicated mechanical tests. Prior to 1989, the rules were generally not mechanical, but rather were applied based on all the facts and circumstances. The valuation date for a defined benefit plan for a plan year must generally be in the same plan year. The multiple use test under section 401(m)(9)(A) would be eliminated. No separately stated revenue estimate ( considered in other provisions ). Directs Treasury to issue regulations by December 31, 2000, to provide that a plan meets section 401(a)(4) if it meets the pre-1994 facts and circumstances tests, meets any new Treasury limits on the pre-1994 test, and is submitted to Treasury for a determination (to the extent provided by Treasury). Effective Date -- The regulations would apply to years beginning after December 31, Any condition of availability prescribed by the Secretary would not apply before the first year beginning not less than 120 days after the date on which such condition is prescribed. Revenue Cost: Directs Treasury to issue regulations by December 31, 2000 to modify existing regulations to expand (as Treasury deems appropriate) the ability of a plan to meet line of business requirements based on a facts and circumstances test even though the plan does not meet the mechanical tests. Gateway test is not repealed. A plan would comply with the minimum coverage requirements of section 410(b) if the plan satisfies the pre-1989 coverage rules, meets any new Treasury limits on the pre-1989 test, and is submitted to Treasury for a determination (to the extent provided by Treasury) as to whether the plan satisfies the pre-1989 coverage rules. Any condition of availability prescribed by the Secretary would not apply before the first year beginning not less than 120 days after the date on which such condition is prescribed. Defined benefit plans that are not underfunded would be allowed to elect to use a valuation date up to one year prior to the beginning of the plan year. The election generally could not apply for more than two consecutive years. Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -11-

12 Effective Date -- The changes would apply to plan years beginning after December 31, Treatment of Multiemployer Plans Under Section 415 Employees of Tax-exempt Entities Improvement to Employee Plans Compliance Resolution System Under section 415(b), annual benefits payable under a defined benefit plan are limited to the lesser of $130,000 (for 1998) or 100% of three-year-high-average compensation. A reduction in the dollar or percentage limit for defined benefit plans may be required if the employee has fewer than ten years of plan participation or service. If benefits commence prior to Social Security retirement age, the dollar limit must be actuarially reduced. Prior to the Small Business Job Protection Act of 1996, tax-exempt entities generally could not maintain section 401(k) plans. Accordingly, the IRS established a special rule under which employees of tax-exempt entities could, under certain circumstances, be excluded in applying the coverage rules to a section 401(k) plan (or a related section 401(m) plan). This special rule could apply, for example, where a tax-exempt entity had a taxable subsidiary that maintained a section 401(k) plan. The Small Business Job Protection Act of 1996 permitted tax-exempt entities to maintain section 401(k) plans. The IRS then terminated the special rule, effective beginning with the 1998 plan year. Failure to satisfy all applicable requirements of section 401(a) or section 403(b) may disqualify a plan or annuity from the intended tax-favored treatment. The IRS has established the Employee Plans Compliance Resolution System (EPCRS) which is a comprehensive system of correction programs for sponsors of retirement plans and annuities that are intended, but have failed, to satisfy the requirements of section 401(a) and section 403(b), as applicable. The basic elements of the programs that comprise EPCRS are self-correction, voluntary correction with IRS approval, and correction on audit. The IRS has expressed its intent that EPCRS be updated and improved periodically in light of experience and comments from those who use it. The section 415(b) limits applicable to multiemployer plans would be modified to eliminate the 100% of compensation limit (but not the dollar limit) for such plans. Effective Date -- The changes would be effective for years beginning after December 31, Revenue Cost: $19 million (5 years). The Secretary would be directed to preserve the special rule in the following form. Employees of a tax-exempt entity who are eligible to make elective deferrals under a section 403(b) arrangement may be excluded in applying the coverage rules to a section 401(k) plan (or a related section 401(m) plan) if (1) no employee of a tax-exempt 501(c)(3) organization is eligible to participate in the section 401(k) (or 401(m)) plan and (2) 95% of the nonexcludable employees who are not employees of a tax-exempt 501(c)(3) organization are eligible to participate in the section 401(k) (or 401(m)) plan. Effective Date -- The change would be effective as if included in the provision of the Small Business Job Protection Act of 1996 that permitted tax-exempt entities to maintain section 401(k) plans. The Secretary of the Treasury would be directed to continue to update and improve EPCRS, giving special attention to (1) increasing the awareness and knowledge of small employers concerning the availability and use of EPCRS, (2) taking into account special concerns and circumstances that small employers face with respect to compliance and correction of compliance failures, (3) extending the duration of the self-correction period for significant compliance failures, (4) expanding the ability to correct insignificant compliance failures using self-correction during audit, and (5) assuring that any tax, penalty, or sanction that is imposed by reason of a compliance failure is not excessive and bears a reasonable relationship to the nature, extent, and severity of failure. Effective Date -- The changes would be effective upon the date of enactment. Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -12-

13 Plans Maintained by International Organizations Notice and Consent Period Regarding Distributions The Taxpayer Relief Act of 1997 exempted governmental plans maintained by State or local governments from various nondiscrimination rules. Governmental plans maintained by an international organization were only exempted from the rule requiring a nondiscriminatory group to be covered. If a participant has a vested benefit in excess of $5,000, that benefit cannot be distributed prior to the later of age 62 or normal retirement age unless the participant consents no more than 90 days before benefit commencement. Such consent is not valid unless the participant receives an explanation of his or her distribution options, including an explanation of the right to defer distributions, no more than 90 days before benefit commencement. In addition, in the case of an eligible rollover distribution, the plan administrator must provide an explanation to the recipient of certain rules regarding the tax treatment of such distribution. This explanation must be provided no more than 90 days before the date of distribution. If a participant in certain types of plans has a vested benefit in excess of $5,000, that benefit must be distributed in the form of a qualified joint and survivor annuity unless such participant and his or her spouse consent to another form no more than 90 days before the annuity starting date. In this regard, a plan must provide a participant with an explanation of his or her distribution options no more than 90 days before the annuity starting date. The same exemptions applicable to State and local government plans would apply to governmental plans maintained by an international organization, i.e., all governmental plans (as defined in section 414(d)) would be exempt from the nondiscrimination and minimum participation rules. Effective Date -- The changes would apply to plan years beginning after December 31, A qualified retirement plan would be required to provide the applicable distribution notice no less than 30 days and no more than 180 days before the date distribution commences. The Secretary of the Treasury would be directed to modify the applicable regulations to reflect the extension of the notice period to 180 days and to provide that the description of a participant s right, if any, to defer receipt of a distribution shall also describe the consequences of failing to defer such receipt. Effective Date -- The changes would be effective for years beginning after December 31, No revenue effect. MISCELLANEOUS Repeal of Unnecessary Transition Rule Provisions Relating to Plan Amendments The Tax Reform Act of 1986, in modifying the definition of highly compensated employee, provided limited grandfather relief from these changes in certain unique circumstances. The Small Business Job Protection Act of 1996 substantially modified the definition of highly compensated employee. Generally, there is a short time within which to make plan amendments to reflect amendments to the law. In addition, the anti-cutback rules can have the unintended effect of preventing an employer from amending its plan to reflect a change in the law. The special 1986 Act grandfather would be repealed in light of the changes in the definition of highly compensated employee. The general rules would apply. Effective Date -- The repeal would apply to plan years beginning after December 31, Revenue Cost: $13 million (5 years). Amendments to a plan or annuity contract made pursuant to any amendment made by the Act are not required to be made before the last day of the first plan year beginning on or after January 1, In the case of a governmental plan, the date for amendments is extended to the first plan year beginning on or after January 1, Operational compliance would, of course, be required with respect to all plans as of the applicable effective date of any amendment made by this Act. Randy Hardock, Barbara Groves Mattox, and John O Neill -- Davis & Harman LLP -13-