A Closer Look at the 2017 Retirement Plan Limits
By now, you are likely aware of the 2017 retirement plan contribution, compensation, and testing limits. But what are the practical implications to retirement plan sponsors? In this edition of Top of Mind, we take a closer look at the numbers and what they may mean to you.
It was an odd year, in that the 402(g) elective deferral did not increase, but the 415 limit and compensation limits did. This happens quite infrequently and is a significant development for plans with highly paid employees and large employer contributions.
In 2016, the “red line” percentage for retirement plan employer contributions was 13.2 percent. Highly-paid employees, earning in excess of the retirement plan compensation limit ($265,000 in 2016), and working at employers contributing in excess of 13.2 percent, were unable to defer the maximum amount to their retirement plan. In 2017, this “red line” percentage will increase to 13.33 percent. While this may not appear to be a significant uptick, it is the first increase since 2014. This is a positive development for highly paid employees, who now have more room in their retirement plan for employer contributions, both on a percentage and dollar basis.
Let’s look at an example of how this works: an employee earns $300,000 per year at an employer that makes a base contribution of 10% and a matching contribution of 100% of the first 5% of elective deferrals. This yields a total of 15% from the employer (assuming the employee defers the amount necessary to receive the full match). In 2016, the compensation of this employee, for plan purposes, is capped at $265,000. The total employer contribution is $39,750, or 15% of $265,000. Since the 415 limit for 2016 is $53,000, the employee can only make elective deferrals to their plan of $13,250 ($53,000-$39,750) or 5% of pay (and not the $18,000 that would normally be the maximum allowed in 2016). So the contribution limits, combined with the large employer contribution, reduce the ability of this highly compensated employee to make elective deferrals. Also note that if the employer match were any larger (say, 100% of the first 6% of pay), the employee would miss out on some of the match as well, as deferral is limited to 5% of capped compensation.
Now let’s take the same example, adjusted for the new 2017 limits. The employee’s compensation for plan purposes in 2017 is capped at $270,000. Therefore, total employer contribution is $40,500, or 15% of $270,000. Since the 415 limit for 2017 is $54,000, the employee can make an elective deferral to the plan of $13,500 ($54,000-$40,500). While it is not anywhere near the $18,000 maximum permitted by law, it is greater than the 2016 limit. Therefore, the elective deferral limit actually increased slightly at a time when the limit for most other participants remained the same.
How do plan sponsors address the inability for highly paid employees to defer the full elective deferral limit into their retirement plans? Most plan sponsors provide a supplemental deferred compensation plan into which such deferrals may be made; often a restoration plan in the corporate world and a 457(b) in the nonprofit sector. Some tax-exempt retirement plan sponsors take advantage of the separate 415 limits for 401(a) and 403(b) plans by establishing a 401(a) plan for employer contributions and a separate 403(b) plan for elective deferrals. The 403(b) plan can be structured to receive additional employer contributions as well, allowing for maximum plan design flexibility, especially for church and governmental plans which are not subject to nondiscrimination rules. Finally, public employers may also establish a 415(m) plan which is a type of plan that was established specifically for 415 excesses.
Now, some of you may be saying, how does the age 50 catch-up provision fit in to all of this? The answer is: it doesn’t! The age 50 catch-up is considered a “freebie,” and is not subject to the limits above. Therefore, employees who are age 50 or older are always able to defer that extra $6,000 (in 2017), regardless of whether their elective deferral limit is $18,000 or something smaller. The only wrinkle is for 403(b) plans that utilize a 15-year catch-up election. Employees eligible for that 15-year catch-up election must exhaust it each year before they can utilize the age 50 catch-up.
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Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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