After many years of proposed pension simplification bills that turned into pension confusion bills we have legislation that truly can be called "Pension Simplification." That's the good news. The bad news is that it doesn't go far enough.

The Small Business Job Protection Act of 1996 (SBJPA) addressed many complex rules relating to 401(k) plans and in most cases simplified compliance with those rules. In addition, SBJPA introduced a new type of retirement plan based on the popular 401(k) plan format. These plans are referred to as SIMPLE IRA and SIMPLE 401(k). The key provisions of standard 401(k) plans affected by SBJPA and the new SIMPLE plans are summarized here. Because space is limited, it will not be possible to go into detail on all existing 401(k) rules and regulations.

Under current law, all 401(k) plans must satisfy a unique nondiscrimination test based on participant deferrals, the so-called "Actual Deferral Percentage (ADP)" and the "Actual Contribution Percentage (ACP)" tests. The purpose of these tests is to ensure that the tax benefits available in 401(k) plans are being used by both rank and file employees as well as "Highly Compensated Employees". Prior to 1997, the statutory definition of "Highly Compensated Employee (HCE)" generally was defined as:

1. A more than 5% owner of the employer,

2. Any employee with compensation from the employer of $100,000 or more (as indexed for inflation),

3. Any officer of the employer with compensation equal to one half the limit on benefits in a defined benefit plan (currently $125,000),

4. Any employee with compensation from the employer of $66,000 or more (as indexed for inflation) and among the top 20% in order of compensation.

Although this definition may seem straightforward, the regulations issued by the IRS as guidance to comply with these rules are certainly not straight forward or simple. For example, in determining the employees that fall into the fourth group there is a separate basis for calculating the number of employees that should be in the so-called 20% group; yet a different group of employees is considered in determining the actual employees that are in the group. In addition, there are lengthy rules regarding which and how many officers should be included as highly compensated.

Once the determination of who is highly compensated is made, the next step is to calculate the actual deferral percentage of that group and compare it to the actual deferral percentage of the "Nonhighly Compensated Employees (NHCE)." As long as the HCE percentage is within allowable statutory limits the plan passes the ADP test. If there is a nonvested matching contribution the same test must be done on the matching contributions, the ACP test, with similar rules. In calculating the ADP and ACP, certain family members must be aggregated and treated as one employee. This computation further complicates compliance and tends to limit the deferrals available to family businesses.

The SBJPA simplifies these rules significantly. First, the requirement to aggregate family members has been repealed. This action has an enormous impact not only on 401(k) plans but on all retirement plans. Next, the definition of Highly Compensated Employee has been simplified to:

1. Any employee whose compensation from the employer for the prior year is $80,000 or more (indexed for inflation), or

2. A more than 5% owner in the prior year or current year. (Table 1 illustrates this change.)

As you can see, prior to 1997, Mr. and Mrs. Owner have been limited due to Manager A being included in the HCE group and the rules under family aggregation. When the result is rerun, based on the SBJPA rules, both Mr. and Mrs. Owner can maximize their deferrals to the statutory limit (for comparison purposes the compensation limit of $150,000 has been kept the same even though the limit for 1997 is $160,000).