For 2018, 401(k) Contribution Limit for Employees Rises to $18,500

For 2018, 401(k) Contribution Limit for Employees Rises to $18,500

'Catch-up' contribution for those 50+ stays at $6,000, while contribution limit from all sources hits $55,000

Stephen Miller, CEBS By Stephen Miller, CEBS October 20, 2017

Update: The IRS issued 2019 retirement plan limits in November 2018; see the SHRM Online article For 2019, 401(k) Contribution Limit for Employees Rises to $19,000.

Employee 401(k) contributions for 2018 will top off at $18,500—a $500 increase from 2017, following two years without a boost—while the "all sources" maximum contribution (employer and employee combined) rises to $55,000, up $1,000, the IRS announced on Oct. 19.

Plan participants who contribute to the limit next year will be able to receive up to $36,500 from match and profit-sharing contributions ($55,000 minus $18,500).

For participants ages 50 and over, the additional "catch-up" contribution limit will stay at $6,000.

HR and payroll managers should plan to adjust their systems for the new year and to inform employees about the new limits in year-end open enrollment materials.

The employee 401(k) contribution increase "is the first since plan year 2015, and reflects a consumer price index increase of 1.97 percent between the third quarters of 2016 and 2017, the largest increase in the past six years," said Brian Donohue, a partner in the Chicago office of October Three Consulting, a retirement plan advisory firm. "Inflation has been historically low during the entire current economic recovery," he noted.

Due to a mild uptick in inflation, rounding rules required the 2018 contribution limits to be increased, while other plan limits that are tied to higher inflation targets remain unchanged. "Although inflation continues to be low, it was enough to finally push up the 401(k) and 403(b) contribution limit in 2018 by $500," said Harry Sit, CEBS, who edits The Financial Buff blog.

2018 Defined Contribution Plan Limits

In Notice 2017-64, the IRS highlighted the following adjustments taking effect on Jan. 1, 2018, for 401(k), 403(b) and most 457 plans:

Defined Contribution Plan Limits 2018 2017 Change
Maximum employee elective deferral $18,500$18,000+$500
Employee catch-up contribution (if age 50 or older by year-end) $6,000$6,000
Defined contribution maximum limit, all sources $55,000$54,000+$1,000
Defined contribution maximum limit (if age 50 or older by year end); maximum contribution all sources plus catch-up $61,000$60,000+$1,000
Employee compensation limit for calculating contributions $275,000$270,000+$5,000
Compensation limit of "key employees" in a top-heavy plan $175,000$175,000
Compensation limit of "highly compensated employees" in a top-heavy plan (HCE threshold) $120,000$120,000

"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 2017-64.

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, of course, 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.

Conversely, high-earners may want to increase their contributions a bit to reach the full annual limit. They also may want to ensure that they don't hit the annual limit prior to year-end, which could mean losing out on employer matching contributions tied to paycheck deferrals, unless the plan sponsor has agreed to "make whole" with the full year's match those participants who max out prior to their final paycheck.

Tax Bill Pulled Back from Changing Contribution Limits

Retirement savings advocates were concerned that  the House and Senate tax bills put before Congress in November 2017 might lower the limit on how much employees could contribute to their 401(k) plans on a pretax basis. . 

As first introduced, the Senate's bill had proposed barring "catch up" contributions for plan participants age 50 and older if they earn $500,000 or more annually, even if made after-tax, but that provision was dropped during the bill's mark-up.

The final bill as enacted in December 2017 made no changes to 401(k) contribution limits.

A Note on Contributing to Multiple Plans

Participants with access to both a 401(k) plan, used by most private employers, and a 403(b) plan, used by many nonprofits—perhaps the account holders have two jobs—can contribute to both the 401(k) and the 403(b) plan, but both plans share a combined annual limit. Each dollar a participant puts in a 403(b) plan reduces the amount they can contribute to the 401(k) plan.

However, the annual limit for a section 457 plan sponsored by a state or local government employer is treated as separate from the 401(k)/403(b) limit. "Many large government employers offer their employees both 401(k) and 457 plans, which enables employees to contribute to both plans, and thus have an opportunity to supercharge their retirement savings," noted William Perez, who blogs on tax issues.

The Senate GOP's tax reform bill proposed to put in place a single aggregate limit on contributions for an employee in a governmental section 457(b) plan and elective deferrals for the same employee under a 401(k) or 403(b) plan. However, that provision was not in the final tax bill enacted at the end of 2017,

401(a) savings plans, used by some educational institutions and nonprofits to fund retirement savings for certain employees, can be a world unto themselves, as Sit explains in a blog post.

2018 Income Tax Brackets and Retirement Plans

The IRS issued income tax bracket adjustments for tax year 2018 on Oct. 19, but these brackets could change if congress were to pass a comprehensive tax reform bill.

The level of income that is subject to a higher tax bracket can influence how much salary employees choose to defer into a traditional 401(k), which reduces taxable income for a given year by the amount contributed, or whether to participate in a nonqualified deferred income plan, if that option is available through their employer.

401(k) After-Tax Contributions

A Roth 401(k) is funded with after-tax dollars and withdrawals are tax-free during retirement, while a "traditional" 401(k) is funded with pretax dollars and withdrawals are taxed as income during retirement.

Many plans allow particpants to covert dollars in a traditional 401(k) account to the plan's Roth account, although the participant must then pay income taxes on all dollars (pretax contributions and earnings) being converted. When withdrawn from the Roth account during retirement, no taxes are subsequently owed.

Some plans, however, will also allow employees to make additional after-tax—but non-Roth—contributions to a traditional 401(k) once the 2018 participant contribution limit of $18,500 (or $24,500 after age 50) is exceeded, up to the "all sources" contribution limit of $55,000 (or $61,000 after age 50).

Employees, especially high earners, "are saying they we want to contribute more inside the 401(k) plan" beyond the annual contribution limit for pretax or Roth contributions, said Wayne Bogosian, president and managing director of PFE Advisors, a retirement plan design and investment advisory firm in Southborough, Mass. In response, plan sponsors are adopting an after-tax contribution feature for traditional 401(k) accounts.

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 Roth dollars within the plan, or to a Roth individual retirement account (IRA), so that the after-tax traditional 401(k) contributions become, effectively, Roth contributions. At the time of the conversion, only earnings are taxed as income, while the dollar amount of the after-tax plan contributions will covert tax free.

Bogosian gave this example:

A participant in 2018 contributes $18,500 to a Roth 401(k) account and then puts another $20,000 into the plan's traditional 401(k) account with after-tax dollars. They've now put $38,500 of their own money into the plan, and they then convert the after-tax $20,000 to the Roth account inside the plan. They are only taxed on the earnings, and if they do the conversion quickly enough before earnings are accrued on the contribution, there may be no or only minimal taxes on the conversion.

"This is definitely a trend we're seeing," Bogosian said, because this approach gives heavy savers who have reached the participant-contribution limit additional access to Roth contributions.

Nondiscrimination Testing Affected

The annual ceiling on employee compensation that can be used to calculate employee-deferral and employer-matching contributions is increasing to $275,000 from $270,000. "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.

But other factors could make passing nondiscrimination testing more difficult, depending on workforce demographics. For instance, the dollar limit used to define a highly compensated employee (HCE) 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," noted Van Iwaarden Associates, a retirement plan services firm in Minneapolis and San Francisco. As a result, "plans may see marginally worse nondiscrimination testing results (including ADP results) if more employees with large deferrals or benefits become HCEs."

Defined Benefit Plan Limits

Regarding defined benefit pension plans, sponsors of traditional pension plans should note that the IRS announced the following cost-of-living adjustments under tax code Section 415, also taking effect on Jan. 1, 2018:

  • Annual benefit limit. The maximum annual benefit that may be provided through a defined benefit plan rises to $220,000 from $215,000.
  • Separation from service. For a participant who separates from service before Jan. 1, 2018, the annual benefit limit for defined benefit plans is computed by multiplying the participant's compensation limit, as adjusted through 2017, by 1.0197. This is an increase from the previous year, when the participant's compensation limit, as adjusted through 2016, was multiplied by 1.0112.

Separately, the federal Pension Benefit Guaranty Corp., which insures private-sector defined benefit pension plans, posted 2018 premium rates for single-employer and multiemployer pension plans.

​"PBGC premium rates will increase a lot next year—more than 7 percent for headcount premiums and almost 12 percent for variable premiums," Donohue observed. "These increases come on top of huge increases sponsors have already seen in the past few years, which tripled total premiums paid between 2011 and 2016."

New Mortality Tables Issued

In October 2017, the IRS released Notice 2017-60, with a new set of final mortality tables that single-employer defined benefit plans will use for minimum funding, maximum benefits, and minimum lump sums, to take effect beginning in 2018. In December 2017, the IRS released Notice 2018-02, with updated mortality tables that defined benefit plans will use beginning in 2019.

SEPs, SIMPLES and Other Plans

  • For SIMPLE (savings incentive match plan for employees of small employers) retirement accounts, the maximum contribution limit remains unchanged at $12,500.
  • For simplified employee pensions (SEPs), the minimum compensation amount remains unchanged at $600.
  • For employee stock ownership plans (ESOPs), the maximum account balance in the plan subject to a five-year distribution period will increase to $1,105,000 from $1,080,000, while the dollar amount used to determine the lengthening of the five-year distribution period rises to $220,000 from $215,000.

"Many small-business owners say they want to set up a 401(k) plan because that is the plan they are most familiar with," said Ken Hevert, senior vice president, retirement products, at Fidelity. "However, after reviewing their situation, small business owners often conclude that perhaps another plan type...may be more appropriate."

He added, "If you know what you are trying to accomplish with a retirement plan, it may be relatively straightforward to determine which plan is most appropriate for the business. For example, is ease of administration an important consideration? Is it critical that employees be able to contribute to the plan? Knowing what you want and need ahead of time is a key component, because each plan has its advantages and disadvantages."

IRA Contributions and Deduction Phase-Out Ranges

The limit for contributions to IRAs for those under age 50 who have earned income from wage earnings remains unchanged in 2018 at $5,500. This limit applies to any type of IRA. People 50 and older in 2018 can make an additional catch-up contribution of $1,000, for a total annual IRA contribution of $6,500.

IRA Contribution Limits 2018 2017 Change
Individual contribution limit $5,500$5,500
Catch-up contribution (if age 50 or older by year-end)*

*The additional catch-up contribution limit for individuals ages 50 and over is not subject to an annual cost-of-living adjustment.

Source: IRS Notice 2017-64.

Although personal IRAs are non-ERISA accounts, the amount that people can contribute annually is affected by whether they have a workplace retirement plan and how much they earn.

The income ranges for determining eligibility to make deductible contributions to traditional IRAs and to contribute to Roth IRAs increased for 2018, as shown below.

Traditional IRA Deduction Phase-Out

Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. If during the year either the taxpayer or his/her spouse was covered by a retirement plan at work, the deduction may be phased out until it is eliminated, depending on filing status and income. The phase-out ranges for 2018 are:

For single taxpayers covered by a workplace retirement plan, the phase-out range is $63,000 to $73,000, up from $62,000 to $72,000.

For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $101,000 to $121,000, up from $99,000 to $119,000.

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 $189,000 and $199,000, up from $186,000 and $196,000.

For married individuals filing a separate return who are covered by a workplace retirement plan, if they lived with their spouse at any time during the year, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Roth IRA income Phase-Out

The adjusted gross income (AGI) phase-out range for taxpayers making contributions to a Roth IRA will be:

For singles and heads of household, the income phase-out range is $120,000 to $135,000, up from $118,000 to $133,000.

For married couples filing jointly, the income phase-out range is $189,000 to $199,000, up from $186,000 to $196,000.

For married individuals filing a separate return, if they lived with their spouse at any time during the year, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Saver's Credit

The income ranges for determining eligibility to claim the Retirement Savings Contributions Credit (commonly called "the saver’s credit") also increased for 2018, as described in an update to the SHRM Online article At Tax Time, Remind Workers About the Saver’s Credit.

The saver's credit helps low- and moderate-income workers to offset part of the initial contribution that they voluntarily make to a 401(k) or similar workplace retirement plan or to an IRA.

Related SHRM Articles:

2018 FSA Employee Cap Rises to $2,650, SHRM Online Benefits, October 2017

2018 Payroll Tax Cap Will Nudge Slightly Higher, SHRM Online Compensation, October 2017

IRS Sets 2018 HSA Contribution Limits, SHRM Online Benefits, May 2016

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