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WASHINGTON-Bipartisan pension legislation introduced in the Senate last week would eliminate a layer of complexity for employers running non-discrimination tests on their 401(k) plans.

Employers would be able to run the same non-discrimination test-known as the 200%/2 percentage points test-on savings plans that have pretax, aftertax and employer matching features.

Allowing employers to run the same non-discrimination test on 401(k) deferrals, aftertax contributions and employer matching contributions, which are covered under Section 401(m) of the tax code, would replace a Byzantine, multistep testing procedure that the Internal Revenue Service put in place nearly a decade ago and that has complicated non-discrimination testing of savings plans ever since.

The legislation, significantly broadened from an earlier draft (BI, July 13), would eliminate 401(k) non-discrimination testing altogether for employers that automatically enroll employees in their 401(k) plans and partially match employees' salary deferrals, while a third provision would allow employees in certain situations to boost contributions to their savings plans.

These proposed changes in the Senate proposal are drawing cheers from benefit professionals.

"Hooray for common sense; I believe these are three terrific things that will help employers and employees," said Margaret-Ann Cole, a principal with PwC Kwasha in Fort Lee, N.J.

The legislative package, as earlier reported, also would liberalize retirement plan cash-out rules, provide a new exemption from minimum distribution rules, accelerate vesting for employers' matching 401(k) contributions, allow employees moving between public and private sectors to transfer account balances to 401(k) plans from 403(b) plans and vice-versa, and lower Pension Benefit Guaranty Corp. premiums for newly established plans that have unfunded liabilities.

Sen. Bob Graham, D-Fla., one of six sponsors of the Pension Coverage and Portability Act, described the bill as a "frontal attack on red tape" that has raised administrative costs and discouraged employers from offering pension programs.

The bill could go on a legislative fast track. Senate Finance Committee Chairman William Roth, R-Del., has a strong interest in including provisions from the package as part of a tax bill congressional Republican leaders are expected to assemble over the next few weeks, Sen. Graham said.

For employers with 401(k) plans, the measure's most significant and welcome administrative change involves the proposed return of multiple use of the 200%-2 percentage points non-discrimination test.

Under a 1986 tax law, employers had been able to use the liberal 200% test to separately test for non-discrimination in both 401(k) deferrals and 401(m) contributions.

But the IRS, making full use of the authority Congress also provided in the 1986 tax law, proposed rules in 1988 to bar employers from using the 200% test twice.

Those rules, which took effect in 1989, established a complex and tougher testing procedure that combines and compares 401(k) deferrals and 401(m) contributions. To pass this tougher test, employers in many cases had to reduce deferrals and contributions to 401(k) plans by higher-paid employees.

By restoring multiple use of the 200% test, employers not only will be able to run a much simpler test, but higher-paid employees also in many cases should be able to bump up their deferrals and contributions to savings plans.

"I love the fact that these multiple tests would be gotten rid of. They are a needless aggravation and a big nuisance," Ms. Cole said.

"This would be a very good change. The 200% test by itself is enough to assure non-discrimination," added Gary Blank, a retirement plan consultant in San Francisco.

Another change in the package would eliminate 401(k) plan non-discrimination testing and comparisons of deferrals by higher-paid vs. rank-and-file employees, though the appeal of this change to employers would be limited.

Under this provision, employers would not have to run the so-called ADP test, short for actual deferral percentage, so long as they:

Automatically enrolled employees in their 401(k) plans and deferred at least 3%-unless employees specifically objected-of an employee's salary to the plan.

Matched 50% of employees' deferrals up to the first 5% of pay.

Immediately vested matching contributions.

In addition, at least 70% of non-highly compensated employees each year would have to make salary deferrals to the plan to win exemption from the ADP test.

Only a relative handful of employers now offer so-called automatic enrollment programs for 401(k)s, though that number is expected to rise in the wake of recent IRS rules that gave the service's blessing to the plans.

Still, while more employers likely would move to such programs if the programs were exempt from non-discrimination testing, the conditions employers would have to meet would limit widespread adoption.

"While this would appeal to some employers, it would not exactly sweep the earth," said Henry Saveth, an attorney with William M. Mercer Inc. in Washington.

Many employers would be reluctant to commit to a 50% match, while others would be deterred by the immediate vesting requirement of matching contributions, he said.

Another proposed change would help lower- and middle-income employees' ability to make higher contributions to their 401(k) plans. That change involves Section 415(c) of the tax code, which limits an employer and employee contributions to a defined contribution plan to $30,000 or 25% of an employee's compensation, whichever is less.

Under the legislation, the new combined employer/employee contribution limit would be 100% of an employee's compensation or $30,000, whichever is less.

This change would be a boon to employees, especially lower-paid workers who are married to high-income spouses and who work for companies that make generous contributions to the lower-paid workers savings plans.

For example, an employee earning $30,000 a year at a company that contributed an amount equal to 10% of employees' salary to a profit-sharing plan, currently could only defer a maximum of 15% of salary, or $4,500, to the 401(k) plan.

Under the Senate bill, though, the higher limit means that employee could defer up to $10,000-the maximum deferral now allowed under law-to the 401(k) plan.

Other provisions in the legislation include:

Modifying a rule that bars employers from automatically removing from their defined contribution plans terminating employees whose account balances ever exceeded $5,000.

The Senate bill would eliminate this lookback rule and set the $5,000 cash-out threshold at the time the employee terminates employment.

Raising to 75 from 701/2 the age at which retirees must take a "minimum distribution" from their defined contribution plans.

In addition, the first $300,000 of a retiree's defined contribution plan account balance would be exempt from the minimum distribution rule and could remain in the plan.

Accelerating 401(k) plan vesting. Employers would have to vest matching contributions within three years if a cliff schedule is used and six years if a graded schedule is used. Currently, matching contributions must vest after five years if cliff vesting is used and after seven years if graded vesting is used.

Allow employees who change jobs to transfer 401(k) account balances to 403(b) plans-the tax-exempt world's rough equivalent of 401(k) plans-and vice-versa. Such transfers now are barred.

Give employers with up to 100 employees a tax credit of $500 per year for the first three years after establishing a new pension plan.

Eliminate fees-now ranging from $100 to $1,500-that the IRS charges employers for providing determination letters for pension plans. A determination letter is the IRS's official judgment that a pension plan meets all applicable Tax Code rules.

Bar 401(k) and other savings plan participants from borrowing against their account balances with credit cards.

Requiring defined contribution plans to provide annual statements to participants indicating the value of accrued benefits. Defined benefit plans would have to provide such statements at least every three years.

Make clear that employers can establish payroll deduction individual retirement account programs for their employees.

Allow employers with up to 100 employees to set up so-called SAFE plans that would be exempt from non-discrimination rules so long as certain rules were followed. Among other things, a SAFE plan would have to provide a minimum benefit equal to 1%, 2% or 3%-with the employer deciding what percentage to use-of an employee's compensation for each year of service.

Other provisions would somewhat ease defined benefit plan nondiscrimination testing rules and extend the PBGC's missing participant program to multiemployer pension plans.