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Catch-Up Contributions: IRS Guidance and Technical Corrections

By Charles W. Sherman Jr.
June 7, 2002

The Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") added section 414(v) to the Internal Revenue Code. This section permits participants age 50 or older to make additional pre-tax contributions, i.e., "catch-up contributions," beginning January 1, 2002. Catch-up contributions may be made under a 401(k) plan, a SIMPLE IRA (as defined in section 408(p)), a SEP (as defined in section 408(k)), a 403(b) arrangement, and an eligible governmental section 457 plan, as well as a traditional or Roth IRA.

The IRS has issued proposed regulations, as well as a notice, providing guidance on how this new provision is to work for retirement plans and contracts, other than IRAs. See Prop. Treas. Reg. § 1.414(v)-1 and Notice 2002-4. Further "guidance" has come from the recently enacted Job Creation and Worker Assistance Act of 2002 (Pub. L. No. 107-147, March 9, 2002) ("JCWAA"), which included pension and other technical corrections to EGTRRA. Changes to section 414(v) were a significant part of the JCWAA pension technical corrections.

The concept of allowing employees nearing retirement to make extra contributions to retirement plans has been well received and, in general, employers are eager to add catch-up contributions to their plans. However, in their attempts to implement catch-up contributions, employers have discovered that the actual operation of catch-up contributions is not as straight forward as one might anticipate from such a relatively simple concept. The proposed regulations, notice, and JCWAA technical corrections clarify some issues, but there are still unanswered questions that need to be addressed in future guidance.

A. The Administration of Catch-Up Contributions

Catch-Up Eligible Participants. Only "catch-up eligible participants" may make catch-up contributions. In order to qualify as a catch-up eligible participant, a participant must meet two requirements. First, the participant must be otherwise eligible to make elective deferrals under the relevant plan or contract. For example, a participant in a defined benefit plan could not qualify as a catch-up eligible participant with respect to the defined benefit plan. Second, the participant must be at least age 50. Participants who would attain age 50 at any time during the calendar year are treated as having attained age 50 on January 1 of that year, so their catch-up contributions will not be affected if they terminate service before they actually reach age 50. See JCWAA § 411(o)(7) and Prop. Reg. §§ 1.414(v)-1(a)(2) and (4).

Catch-Up Contributions. Catch-up contributions are elective deferrals, or contributions to an eligible governmental section 457 plan, that exceed an otherwise "applicable limit." See Prop. Reg. § 1.414(v)-1(a)(3). There are three types of applicable limits --

  • Statutory limits, such as those described in sections 401(a)(30), 402(h), 403(b)(1)(E), 404(h), 408(k), 408(p), 415 and 457.
  • The ADP nondiscrimination test limit (or, in the case of a SARSEP, the limit described in section 408(k)(6)(A)(iii)).
  • Plan limits, established at the employer's discretion for administrative or compliance (e.g., ADP test) reasons. For example, many plans state that participant contributions may not exceed a stated percentage of compensation. The regulations expressly provide that a plan limit must be stated in the plan document.

A Treasury official has stated informally that if a plan permits catch-up contributions, it must permit catch-up contributions with respect to any of the applicable limits; for example, it cannot treat as catch-up contributions only amounts in excess of the statutory limit.

Because catch-up contributions are treated as elective deferrals, a plan generally may account for them in the same manner as other elective deferrals. Separate accounting is not required, except to determine initially whether or not an elective deferral is a catch-up contribution. A Treasury official has informally indicated that their status as elective deferrals also means that they are subject to many of the provisions generally applicable to the particular type of elective deferrals (e.g., 401(k), 403(b), or 457 deferrals), including distribution restrictions and the requirement that they must be deferred before they are currently available.

Maximum Amount of Catch-Up Contributions. Catch-up contributions must be made out of current income. This means that an individual's aggregate elective deferral contributions (including catch-up contributions) may not exceed the individual's compensation. In addition, catch-up contributions may not exceed either of the following limits:

General Catch-Up Amount:
Tax Year Amount SIMPLE 401(k)/IRA
2002 $1,000.00 $500.00
2003 $2,000.00 $1,000.00
2004 $3,000.00 $1,500.00
2005 $4,000.00 $2,000.00
2006 $5,000.00 $2,500.00

After 2006, the limit on catch-up contributions will be adjusted for inflation in $500 increments. See Prop. Reg. § 1.414(v)-1(c).

As with other elective deferrals, the limit on catch-up contributions generally applies on an individual participant basis, and not on a plan-by-plan or controlled group basis. Accordingly, in determining whether a participant's catch-up contributions exceed the maximum limit, the participant generally must aggregate all catch-up contributions made on his or her behalf. See Prop. Reg. § 1.414(v)-1(g)(2). However, because pre-tax contributions to eligible 457 plans are not treated like other elective deferrals, participants covered by a governmental 457 plan and a 401(a) or 403(b) plan may make the maximum catch-up contributions to both plans in the same year.

Timing of Determination of Catch-Up Contributions. In general, whether or not an elective deferral will be considered a catch-up contribution is determined at the end of the plan year. This is because the regulations require that whether an elective deferral exceeds a plan limit cannot be determined until the end of the plan year. See Prop. Reg. § 1.414(v)-1(b)(2). This is true even if contribution limits are determined under the plan on a payroll-by-payroll basis. See Prop. Reg. §§ 1.414(v)-1(b)(2) and (i) (Example 3). However, in certain cases, a statutory limit may be determined on the basis of the calendar year or a fiscal year instead of the plan year. For example, whether or not amounts exceed the section 402(g) limit is determined on a calendar year basis. For statutory limits, the determination of whether elective deferrals are in excess of the limit is made on the basis of the applicable fiscal or calendar year. See Prop. Reg. § 1.414(v)-1(b)(2)(ii).

It follows from the timing rule for statutory limits that there is an implicit ordering rule for determining catch-up contributions. First, whether or not contributions are in excess of the section 402(g) limit is determined as of the time of deferral, and any excess amounts are treated as catch-up contributions (up to the catch-up limit). Next, at the end of the plan or limitation years, it is determined whether any other statutory or plan limits are exceeded, and excess amounts are treated as catch-up contributions (up to the catch-up limit). Finally, the ADP test (or the test under section 408(k)(6), if applicable) is performed, and excess contributions of eligible catch-up participants are treated as catch-up contributions (up to the catch-up limit). See Prop. Reg. § 1.414(v)-1(i) (Example 2).

Treatment of Catch-Up Contributions Under the Plan. Catch-up contributions are ignored for purposes of most Code limits. The regulations expressly state that they are not taken into account in applying the following limits: 401(a)(30), 401(k)(11), 402(h), 402A(c)(2), 403(b), 404(h), 408(k), 408(p), 415, or 457. See Prop. Reg. § 1.414(v)-1(d)(1). In addition:

  • ADP Testing: Contributions in excess of a plan or statutory limit, to the extent characterized as catch-up contributions, are disregarded in performing the ADP test. If, after the test is performed, corrective action is necessary to meet the test, the plan must treat the excess contributions as catch-up contributions, up to the catch-up contribution limit, instead of distributing them. If the plan does not provide for matching contributions on catch-up contributions, any matching contributions made with respect to amounts recharacterized as catch-up contributions must be forfeited. See Prop. Reg. §§ 1.414(v)-1(d)(2)(i), (ii), and (iii).
  • Top-Heavy Plans: In determining current year contributions for key employees in a top-heavy plan, catch-up contributions are ignored. However, catch-up contributions made in prior years are taken into account in determining whether a plan is top-heavy (i.e., as part of the account balances). See Prop. Reg. § 1.414(v)-1(d)(2)(iv).
  • Average Benefit Percentage Testing: In determining whether a plan satisfies the average benefit percentage test under section 410(b)(2), catch-up contributions for the current year are ignored. Thus, catch-up contributions are ignored if benefit percentages are based on current year contributions. However, prior year catch-up contributions are taken into account if benefit percentages are based on accrued-to-date calculations. See Prop. Reg. § 1.414(v)-1(d)(2)(v).
  • Benefits, Rights, and Features: Allowing catch-up contributions to all catch-up eligible participants is deemed not to result in a discriminatory benefit, right, or feature (BRF) under section 401(a)(4). See Prop. Reg. § 1.414(v)-1(d)(3).
  • Matching Contributions: A plan may match all elective deferrals, or may exclude catch-up contributions from the match, without the matching formula being considered a separate BRF as applied to catch-up eligible participants. See Prop. Reg. § 1.414(v)-1(d)(3). Any matching contributions made on catch-up contributions must be aggregated with other matching contributions in performing the ACP test.

Universal Availability and Participant Elections. Catch-up contributions to a plan subject to testing under Code section 401(a)(4), including employer contributions to a 403(b) plan subject to discrimination testing, must be "universally available." Under this rule, if an employer permits catch-up contributions to a plan, then that employer must provide all catch-up eligible participants in the plan with the "effective opportunity to make the same dollar amount of catch-up contributions." Prop. Reg. § 1.414(v)-1(e)(1). The Proposed Regulations indicate that the effective opportunity requirement is not violated by allowing participants to defer for each pay period a percentage of compensation and also a pro rata amount of the annual catch-up contributions limit. The Regulations also state that effective opportunity is not violated if different deferral limits apply to different groups of employees, as long as lower limits do not apply to catch-up eligible participants.

In our experience, most sponsors have implemented catch-up contributions under a "single election" approach. Under this approach, the plan applies a percentage limit on "regular" elective deferrals for each pay period, and permits deferrals above the "regular" limit. For example, if the plan permitted 401(k) deferrals each pay period of up to 25% of compensation, deferrals above this percentage of plan year compensation (or above the 401(k) statutory contribution limit) would be treated as catch-up contributions up to the catch-up limit. Alternatively, a sponsor could adopt a "separate election" approach and require separate elections for regular deferrals and catch-up contributions.

It is unclear if a plan with any cap on total deferrals provides lower paid participants with the effective opportunity to make "the same dollar amount of catch-up contributions" as higher paid employees. Since lower paid employees will not be subject to the ADP test limit and may hit the 402(g) limit only rarely, it seems that their effective opportunity to make nominal catch-up contributions must generally be based on contributions in excess of a plan limit. However, as discussed above, whether or not these extra deferrals will actually be treated as catch-up contributions cannot be determined until the end of the plan year, based on whether total elective deferrals exceed the percentage limit on regular deferrals times plan year compensation. It would seem that the lowest-paid participants would need to be permitted to defer up to 100% of compensation to satisfy (if mathematically possible) the "same dollar amount of catch-up contributions" requirement if the "same dollar amount" requirement is measured at the end of the year. On the other hand, it is not clear that the end of the year is the required measuring point, and the "same dollar amount" requirement might be satisfied by nominal catch-ups made during the year.

Universal Availability and Controlled Groups. As noted above, catch-up contributions to a plan must be "universally available." If there are multiple "elective deferral" plans in the controlled group, compliance with this requirement is based on the controlled group. So, if one employer in a controlled group provides catch-up contributions under a 401(k) plan, all other employer plans (other than a section 457 plan) in the controlled group that provide for elective deferrals and that are subject to section 401(a)(4) must permit catch-up contributions. See Prop. Reg. § 1.414(v)-1(e). An IRS spokesperson has informally stated that the "separate line of business" provisions will not be applicable in this context.

The universal availability requirement has been problematic in the context of controlled groups that sponsor more than one plan. It appeared that anything but a uniform implementation date for all controlled group plans would violate the universal availability rule. Employers have expressed uncertainty as to whether they could coordinate the implementation of catch-up contributions as of a uniform date. Notice 2002-4 addresses this problem by providing a transition rule for 2002. Basically, the new guidance provides that, as long as all applicable employer plans maintained by controlled group members permit catch-up contributions by October 1, 2002, the plans will be treated as meeting the universal availability requirement, even if they implement catch-up contributions on different dates in 2002.

There are two exceptions to the principle that the universal availability rule applies to all plans in a controlled group. The first exception applies to a plan acquired through a merger, acquisition, or similar transaction. In this case, the newly acquired plan does not have to provide for catch-up contributions until the end of the two-year transition period described in section 410(b)(6)(C). See JCWAA § 411(o)(6) and Notice 2002-4.

The second exception applies to a plan qualified under Puerto Rican law. Puerto Rico has its own laws applicable to tax-favored retirement plans and these laws do not permit catch-up contributions. Accordingly, since tax-favored plans covering Puerto Rican employees can not provide for catch-up contributions, applicable employer plans that are qualified under Puerto Rican law can be ignored for the purposes of determining if the universal availability requirement has been met by other controlled group plans. See Notice 2002-4.

Union Plans. The universal availability rule applies to an employer's union plans, as well as its non-union plans. This apparently means that if a union does not agree in bargaining to permit catch-up contributions to the plan, the employer is prevented from offering catch-up contributions in any of its plans. If there are multiple unions and multiple union plans, an employer will need to proceed carefully to satisfy both labor law and the universal availability rule. Many commentators had urged Treasury to adopt a "mandatory disaggregation" approach for unions and nonunions like that in the section 410(b) regulations, but Treasury believes the statutory language in section 414(v) is clear on this point, and would not agree even to including a "fix" in the JCWAA pension technicals.

The regulations provide a transition rule for plans maintained pursuant to a collective bargaining agreement. If a collective bargaining agreement is in effect on January 1, 2002, the plan is not taken into account for universal availability purposes until the first plan year beginning after the agreement terminates. Presumably, if an employer allows its non-union employees to make catch-up contributions beginning in 2002, it might have to eliminate this option if a union does not agree to make catch-up contributions available to its members by the end of the transition period.

Catch-Up Contributions Under Multiple "Controlled Group" Plans. Some statutory limits apply to plans on a controlled group basis. For example, the limit on elective deferrals imposed by sections 401(a)(30) and 402(g), are applied (at least in part) by aggregating all plans in the controlled group. Similarly, in determining catch-up contributions, whether or not elective deferrals are in excess of the section 402(g) or other applicable limit is determined on a combined plan basis. See JCWAA § 411(o)(3) and Prop. Reg. § 1.414(v)-1(f)(1).

However, because pre-tax contributions to eligible 457 plans are not treated like other elective deferrals, 457 plans are not aggregated with other plans in applying the limit on catch-up contributions. This means that participants covered by a governmental 457 plan and a 401(a) or 403(b) plan may make the maximum catch-up contributions to both plans in the same year. See JCWAA § 411(o)(3) and Prop. Reg. § 1.414(v)-1(f)(1).

In addition, the regulations provide that, in certain contexts, an employer-provided limit will be determined on a controlled group basis. Specifically, the proposed regulations provide that, in determining whether a highly compensated employee's elective deferrals exceed an employer-provided plan limit, the applicable limit is the sum of the dollar amount limits under the separate plans. See Prop. Reg. § 1.414(v)-1(f)(2). The Preamble suggests that this treatment follows from the fact that, in calculating the ADP for a highly compensated employee who participates in more than one 401(k) plan, the employee's 401(k) contributions under all plans are aggregated.

If elective deferral contributions in excess of a statutory or employer-provided plan limit are determined on an aggregate basis, catch-up contributions must be allocated among the plans. The regulations provide that any reasonable allocation that is consistent with the manner in which the elective deferral contributions were made is permissible. For example, if a catch-up eligible participant participates in a 401(k) plan for the first half of the year and in a 403(b) arrangement for the second half of the year, and the participant reached the 402(g) limit during the second half of the year, it would be reasonable to treat the catch-up contributions as arising solely from the 403(b) arrangement as long as the amount of catch-up contributions does not exceed the amount of the 403(b) contributions. See Prop. Reg. § 1.414(v)-1(f)(3).

Special Rule for Participants in Multiple Plans of Unrelated Employers. An issue arises when an individual terminates employment with one employer in the middle of the year and begins employment with an unrelated employer. If that individual participates in a 401(k) plan sponsored by each employer, his elective deferrals to each plan might not exceed a statutory or plan limit. In addition, his contributions might be permissible under the ADP test. In this event, a catch-up eligible participant may treat contributions in excess of the 402(g) limit as catch-up contributions. This treatment, which is generally consistent with the operation of the section 402(g) elective deferral limit, is deemed to have no impact on the plans -- they will not have to rerun their ADP tests to exclude the catch-up contributions. See Prop. Reg. § 1.414(v)-1(g).

Special Coordination Rule for Section 457 Plans. In the case of an eligible section 457 governmental plan, catch-up contributions are not permitted for any catch-up eligible participant in any taxable year for which the extra contributions permitted under section 457(b)(3), relating to the last 3 years before retirement, applies. See JCWAA §§ 411(o)(8) and (9) and Prop. Reg. § 1.414(v)-1(h). The regulations "reserve" space for a special rule for "coordinating" the current 403(b) catch-up rules (sec. 402(g)(7)) with the new catch-up rule. As the Code now reads, both are permitted (if the person otherwise qualifies for both rules).

Plan Amendment to Allow Catch-Up Contributions. A qualified plan providing for catch-up contributions must adopt a "good faith" amendment by the end of the plan year in which the catch-up contributions are first permitted. This means that a calendar year plan allowing catch-up contributions beginning on January 1, 2002, must be amended by December 31, 2002. Notice 2001-57 provides a sample amendment that can be used for this purpose. Presumably, similar timing of amendment rules apply to 403(b) or 457 plans.

Reporting Catch-Up Contributions. Under IRS Announcement 2001-93, catch-up contributions should be reflected in box 12 of Form W-2. For 2002, they will be included in the total numbers reported for Codes D through H and S. The reporting of catch-up contributions on Form 5498 will be addressed in the 2002 Instructions for Forms 1099-R and 5498.

B. Unresolved Issues

Many important issues remain unresolved. For example:

• Impact on Safe-Harbor Plans. How do catch-up contributions fit within the context of the 401(k) safe harbor? If the safe-harbor matching contributions are applied to catch-up contributions, will the plan fail to meet the safe-harbor?

  • Application of IRS Compensation Limit. Because the catch-up rules are complex and guidance was issued late in 2001, some employers may wish to add the provision after the beginning of 2002. One question that raises is whether eligible participants who reached the $200,000 compensation limit before the addition of the provision may still make catch-up contributions. Informally, Treasury and IRS officials state that catch-up (and other participant contributions) may be made from more than $200,000 in compensation as long as the amount of the plan limit (which cannot exceed the maximum plan percentage times $200,000) is not exceeded.
  • Negative Elections. Can a plan establish a "negative election" for catch-up contributions on the same basis as for elective deferrals?
  • Correction of Excess Catch-Up Contributions. If catch-up contributions are made on a payroll-by-payroll basis, it is possible that excess catch-up contributions might be made, especially if they are made to more than one plan during a year. Can a plan "correct" excess catch-up contributions if they are not in excess of the 402(g) limit or the ADP test? May they be distributed?
  • Exclusion of Catch-Up Contributions. If a participant makes contributions in excess of the 402(g) limit to two plans of different employers, what steps should he or she take in order to treat the excess contributions as catch-up contributions?
  • State Law Non-Conformity. As of Spring 2002, several states have not updated their state income tax laws to mirror the Code after EGTRRA. Efforts are being made in these states to conform state law to EGTRRA, but whether all will do so in 2002 is unclear. If not, one result in non-conforming states would be that catch-up contributions would be subject to state income tax.
    C. Implications

Despite the uncertainties described above, it appears that many companies are planning to implement catch-up contributions this year. There are many preliminary steps that must be taken before catch-up contributions can be rolled out to employees. For example, a list of catch-up eligible participants must be compiled; an employee communication describing the catch-up contribution must be drafted and distributed; and administrative systems must be modified to track the potential catch-up contributions. Therefore, companies that want to implement catch-up contributions this year should begin the preliminary steps as soon as possible. This is especially true for controlled groups with more than one plan; these plans can take advantage of the special transition rule allowing implementation on different dates for different plans only until October 1, 2002.