Do you know your limits? retirement plan limits that is.
With retirement plans, as with other facets of your business, it is important to understand and monitor limits imposed by various laws and regulations. One challenge in monitoring retirement plans limits, however, is that they are constantly changing.
Each year in October, the IRS announces the cost-of-living adjustments (COLAs) that will apply for the following calendar year. In a separate pronouncement, the Social Security Administration announces the adjustment to the taxable wage base. This chart provides the limits for 2018. It also illustrates how the limits have changed over the past few years for defined contribution plans. In some years, the increase in the cost-of-living index does not meet the statutory thresholds that trigger increased limits.
2018 COLA INCREASES*
Explanation of Plan Limits*You can find the complete IRS COLA Increase Table at
Following is a refresher for plan sponsors on how the annual limits affect plan operations.
Annual Compensation (a/k/a Compensation Cap)
Only a certain amount of a plan participant’s compensation may be used to calculate contributions or to perform nondiscrimination tests. For example, for 2018, if a participant earns $300,000 in compensation, the employer may only calculate the participant’s share of a profit sharing contribution based on $275,000. This is the annual compensation limit in effect for the year.
A participant’s salary deferrals (pre-tax and Roth) made to 401(k) and 403(b) plans cannot exceed $18,500 for 2018, plus up catch-up contributions. Participants who also participate in a governmental 457(b) plan have a separate deferral limit of $18,500 for that plan.
Participants age 50 or older may defer an additional $6,000 each year over the elective deferral limit. 403(b) plans and governmental 457(b) plans may have additional special catch-up provisions.
Defined Contribution Plan Limit (a.k.a. Annual Additions Limit)
All employee and employer contributions allocated to a plan participant’s account for 2018 cannot exceed the lesser of:
- 100% of the participant’s compensation or
- $55,000, plus catch-up contributions.
An HCE (highly compensated employee) is an employee who:
- Owns more than 5% of the employer at any time during the year or preceding year, or
- Earned more than $120,000 for 2018 from the employer. And, if the employer elects, had compensation that ranked the employee in the top 20% of all employees.
HCE status determines how to categorize employees for the 401(k) plan nondiscrimination tests. Both the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test. The ADP test limits the percentage of compensation the HCE group can defer into the 401(k) plan, based on the deferral rate of the non-highly compensated employee (non-HCE) group. The ACP test ensures that the employer matching contributions and after-tax employee contributions contributed for HCEs are not disproportionately higher than those for non-HCEs.
A key employee is an employee who
- Owns more than 5% of the employer,
- Owns more than 1% of the employer and has an annual compensation of more than $150,000, or
- Is an officer of the employer and has compensation of more than $175,000 (for 2018).
Key employee status determines how to categorize employees for the top-heavy test. The test measures whether plan assets are concentrated in the accounts of business owners or officers of the company earning a certain amount of compensation. A plan is top-heavy if more than 60% of its assets are in the accounts of key employees. The determination is made as of the last day of the preceding plan year (December 31 for a calendar-year plan). If the plan fails the top-heavy test as of December 31, 2018, it will be considered top-heavy for 2019.
Taxable Wage Base
The taxable wage base is the maximum amount of an employee’s compensation that is subject to Social Security tax. They also use this limit when allocating certain employer contributions in retirement plans that use the permitted disparity contribution formula (also known as Social Security integration).
Even small changes in these dollar amounts can result in employees moving among HCE and non-HCE groups or key vs. non-key employee classes, which can affect plan testing results. And, any change to the contribution limits requires adjustments in payroll systems and internal procedures designed to make sure plan contributions stay within the allowed limits. Plan advisors, recordkeepers, and third-party administrators (TPAs) are among the best resources to help plan sponsors understand how annual COLA adjustments affect their plan. Plan sponsors may want to
- Review COLA adjustments each year with their internal payroll staff or outsourced payroll company to make sure all necessary adjustments are made.
- Analyze last year’s nondiscrimination testing results to determine whether changes to the groups of employees classified as HCEs or key employees could affect this year’s tests. A plan advisor can help explore plan design changes (e.g., safe harbor 401(k) plans) to prevent failed testing in the future.
- Communicate the contribution limit increases to plan participants to encourage stronger retirement savings.
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