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Reaching the 401(k) contribution ceiling can be a long-term savings goal
Updated on Nov. 4, 2016
Employee 401(k) contributions for plan year 2017 will once again top off at $18,000 with an additional $6,000 "catch-up" contribution allowed for those turning age 50 or older. But maximum contributions from all sources (employer and employee combined) will rise by $1,000.
A few other defined contribution and defined benefit plan limits will be adjusted upward,
the IRS announced on Oct. 27, when it
issued Notice 2016-62.
But for employee contributions—the elective deferral limit—the news is "no changes two years running now," said Brian Donohue, a partner with October Three Consulting, a plan advisory firm in Chicago. The last increase was a $500 jump from 2014 to 2015.
Annual limits and maximums for 401(k) and similar defined contribution retirement plans are largely holding steady because there wasn't much of an increase in the cost-of-living index—up 1.09 percent between the third quarters of 2015 and 2016—which, in many instances, failed to meet the statutory thresholds that trigger rate adjustments.
For employer-provided contributions to 401(k)-type plans, "annual limits are up close to 2 percent," Donohue noted. Employers can contribute an additional $1,000 next year even if plan participants contribute to the individual limit. The annual defined contribution limit from all sources increases from $53,000 to $54,000 (plus the $6,000 catch-up if age 50 or older), or 100 percent of an employee's compensation.
"Since the deferral limit didn’t increase, this means that any additional DC benefits will have to come from higher employer contributions," notes
a commentary by Van Iwaarden Associates, a retirement plan services firm in Minneapolis and San Francisco. "Individuals can now receive up to $36,000 from match and profit-sharing contributions ($54K – $18K)."
[SHRM members-only Toolkit: Designing and Administering Defined Contribution Retirement Plans]
Defined Contribution Plans
The IRS highlighted the following adjustments taking effect on Jan. 1, 2017, for 401(k), 403(b) and most 457 plans:
"Key employees" and "highly compensated employees" are terms used for testing purposes in the annual nondiscrimination testing of a retirement plan.
The $6,000 catch-up contribution limit for participants age 50 or older applies from the start of the year to those turning 50 at any time during the year.
Source: IRS Notice 21016-62.
The annual ceiling on employee compensation that can be used to calculate employee-deferral and employer-matching contributions is increasing to $270,000 from $265,000. "The pay cap increase will lessen the impact on
annual nondiscrimination testing of maximum deferrals taken by high-earners," at least somewhat, Donohue said, referring to the annual nondiscrimination tests—the actual deferral percentage (ADP) test and actual contribution percentage (ACP) test that a qualified retirement plan must satisfy.
"High-paid participants will now have more of their compensation 'counted' towards qualified plan benefits and less towards nonqualified plans, noted Van Iwaarden. "This could also help plans’ nondiscrimination testing if the ratio of benefits to compensation decreases."
But other adjustments could make passing nondiscrimination testing more difficult. For instance, the dollar limit used to define a highly compensated employee for nondiscrimination testing will stay at $120,000 next year.
"When the HCE compensation threshold doesn’t increase to keep pace with employee salary increases, employers may find that more of their employees become classified as HCEs," said Van Iwaarden. As a result, "plans may see marginally worse nondiscrimination testing results (including ADP results) if more employees with large deferrals or benefits become HCEs. It could make a big difference for plans that were previously close to failing the tests." Also, "More HCEs means that there are more participants who must receive 401(k) deferral refunds if the plan fails the ADP test."
Although the limit used to define a highly compensated employee for nondiscrimination testing remains at $120,000, the dollar limit for defining key employees in a top-heavy plan rises to $175,000 from $170,000.
A Savings Goal
HR professionals should convey to employees their plan contribution limits for next year. Not all plan participants will be able to fund their 401(k) accounts up to the maximum, but the contribution cap is a goal they should keep in mind and may encourage those who can defer extra dollars for retirement savings to do so.
Communicating how much employees are allowed to contribute annually "may improve the signaling to employees, highlighting the importance of retirement savings," said Fredrik Axsater, senior managing director and global head of defined contribution (DC) plans at State Street Global Advisors in San Francisco. Plan participants may assume that
the default savings rate in automatic enrollment plans, typically around 3 percent of salary, is the "correct" amount to contribute, whereas many retirement advisors
suggest a savings rate of 10 to 15 percent of annual compensation throughout employees' working years, on average.
Conversely, high-earners may want to ensure that they don't hit the annual contribution limit prior to year-end, which could mean
losing out on employer matching contributions tied to paycheck deferrals.
"Highly compensated employees who may be limited in the amount that they are able to contribute to a 401(k) on a tax-preferred basis will need to increasingly look outside of a DC plan to increase their retirement savings" especially given that the employee contribution cap will not increase next year, Axsater said. Contributing
the maximum allowed to a health savings account with investment offerings is one option he suggested.
"While the contribution limits haven't changed, there's still room to improve behaviors," said Ross Bremen, a partner and head of DC strategies at retirement plan advisors NEPC in Boston. "The tools are there to get participants saving at a sufficient rate," including automatic enrollment, automatically increasing contributions each year and using diversified default investments such as target-date funds, he noted. "Plan sponsors are looking for ways to take advantage of the tools that exist, whether it's using auto features or looking for ways to
stretch the match structure to get people contributing at higher rates."
After-Tax (Non-Roth) Contributions
Roth 401(k)s are funded with after-tax dollars and withdrawals are tax-free during retirement, while "traditional" 401(k)s are funded with pretax dollars and withdrawals are taxed as income during retirement.
Some plan sponsors will allow employees to make additional after-tax—but non-Roth—contributions to a traditional 401(k) once the $18,000 (or $24,000 after age 50) participant contribution limit is exceeded, up to the 2017 IRS limit of $54,000 (or $60,000 after age 50) for 401(k) contributions from all sources.
If the plan document allows contributions to a non-Roth
after-tax 401(k), then by following the correct steps
employees can convert these contributions to a Roth individual retirement account (IRA), so that the after-tax traditional 401(k) contributions become, effectively, Roth IRA contributions. That gives heavy savers more access to Roth contributions than would be the case if they relied solely on direct Roth 401(k) and Roth IRA contributions. But given that most 401(k) participants don't contribute up to the standard limit, Axsater viewed this as "a benefit for a small percent of participants."
There's also a catch: unlike contributions, made to the account, any investment earnings tha thave built up in a non-Roth after-tax 401(k) can be rolled over to a traditional IRA but not to a Roth IRA, so those earnings will be taxed as income when withdrawn.
2017 Income Tax Brackets
Income tax bracket adjustments for tax year 2017 were issued by the IRS on Oct. 25, 2016. The level of income that is subject to a higher tax bracket can influence a number of decisions by employees, including how much salary to defer into a traditional 401(k), which reduces taxable income for a given year by the amount contributed.
Defined Benefit Plans
Regarding defined benefit pension plans and other retirement savings vehicles, the IRS announced the following adjustments under tax code Section 415:
Separately, the federal Pension Benefit Guaranty Corp., which insures private-sector defined benefit pension plans,
posted 2017 premium rates for single-employer and multiemployer pension plans.
Other Workplace Retirement Plans
• For single taxpayers covered by a workplace retirement plan, the phase-out range is
$62,000 to $72,000, up from $61,000 to $71,000.• For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is
$99,000 to $119,000, up from $98,000 to $118,000.• For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple's income is between
$186,000 and $196,000, up from $184,000 and $194,000.• For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
Among the few other changes announced by the IRS, the adjusted gross income limit for the saver's credit (also known as the
retirement savings contributions credit) for low- and moderate-income workers will rise to
$62,000 for married couples filing jointly, up from $61,500;
$46,500 for heads of household, up from $46,125; and
$31,000 for singles and married couples filing separately, up from $30,750.
The saver's credit
helps offset part of the initial contribution workers voluntarily make to 401(k) plans, similar workplace retirement programs or IRAs.
Related SHRM Articles—Retirement Plans:
How to Navigate the Compensation Options in 401(k) Plans,
SHRM Online Benefits, November 2016
Are 401(k) Vesting Schedules in Need of an Update?,
SHRM Online Benefits, October 2016
Related SHRM Articles—2017 Benefit Adjustments:
In 2017, FSA Contribution Cap Rises to $2,600,
SHRM Online Benefits, November 2016
2017 Payroll Taxes Will Hit Higher Incomes,
SHRM Online Compensation, October 2016
IRS Sets 2017 HSA Contribution Limits,
SHRM Online Benefits, May 2016
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