Retirement Plans With Individual Accounts: Federal Rules and Limits

Publication Date: February 2003

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

Type:

Abstract:

As the federal income tax grew in importance during the 1940s, 1950s, and 1960s, employers devised ways in which employees could defer receipt of a part of their pay to postpone taxation of that income. These salary deferrals often were intended to be used in retirement. Most such plans now penalize cash withdrawals before a certain age, with exceptions for circumstances such as death, disability, or financial hardship. Thus, they often are called salary reduction retirement plans.

The manner in which deferred compensation plans were initially established varied among employment sectors. Business firms’ plans differed from those of educational organizations, which in turn differed from government plans. The various plan types were codified over the years as Congress responded to regulatory initiatives by the Internal Revenue Service and to concerns about loss of revenue and the fairness and integrity of these plans. The resulting statutes reflected the unique history of each plan type.

Congress began to move toward more uniformity in the rules governing the different types of salary reduction plans in 1986 with passage of the Tax Reform Act of 1986 (P.L. 99-514), which contained several provisions that reduced disparities in plan rules. In 1996, Congress made additional changes in plan rules in the Small Business Job Protection Act of 1996 (P.L. 104-188), and further changes were made a year later by the Taxpayer Relief Act of 1997 (P.L. 105-34). In 2001, the Economic

Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16) raised contribution limits substantially, liberalized the rules permitting tax-free transfers of assets among different types of plans, shortened the maximum service required for employees to become vested in employer contributions, established a nonrefundable income tax credit for retirement plan contributors with income below specified levels, and made numerous other changes.

This report describes each type of salary reduction retirement plan authorized by federal law: individual retirement accounts (IRAs), §401(k) plans, the Federal Employees’ Thrift Savings Plan, §403(b) plans, §457 plans, salary reduction simplified employee pension (SARSEP) plans, and savings incentive match plans for employees of small employers (SIMPLE). The rules governing these plans are then presented in regard to: eligibility, vesting, tax treatment of contributions, limits on contributions, limits on investments, withdrawal options, and tax treatment of withdrawals. Exceptions to the general rules are noted for specific plan types.

Appendix A to this report compares the rules for each plan type in chart form. Appendix B explains the abbreviated terms used in this report. Appendix C lists the major provisions of law by statute and section number. This report is updated annually.