The IRS announced in October the 2015 cost-of-living increases to limits on contributions, benefits, and considered compensation for pension plans and retirement related items. Most payroll systems are automatically updated to hardcode the limit on pre-tax and Roth deferrals, but many may not be designed to limit employer (e.g. matching, fixed non-elective) for employees with earnings in excess of the annual compensation limit. It's best to review the capabilities and limitations of payroll software in place in the beginning of the year, rather than catch (and have to fix) excess deposits to your retirement plan later.
The deferral limit that applies to 401(k), 403(b), and most 457 plans, has been increased to $18,000 (or 100% of eligible compensation, if less) for 2015. If your plan offers pre-tax and Roth deferrals, this limit applies to each individual participant, not to each deferral type. In other words, a participant can contribute up to $18,000 in deferrals to the plan, whether all pre-tax, all Roth, or some combination thereof (e.g. $9,000 to pre-tax and $9,000 to Roth). If you offer both a 401(k) and 403(b) plan, the limit of $18,000 applies to an individual's combined deferral contributions. The deferral limit for a 457 plan, though, is considered as a stand-alone limit.
Catch-up contributions, increased to $6,000 for 2015, are also permitted for individuals that attain age 50 or older during the year. For those turning 50 in 2015 (first of all, congrats), you do not need to wait until that date to be eligible to contribute the catch up - it's considered available as of January 1st of the year in which you turn 50, rather than a switch that's flipped on your actual birthday. This means that a participant born in 1965 or earlier can defer up to $24,000 in 2015 in a 401(k), 403(b), or governmental 457(b) plan (if the plan document permits). Note that age 50+ catch-up contributions are not permitted in nongovernmental 457(b) plans.
Other special catch-up contributions may be available to individuals covered by a 403(b) or 457(b) plan. These special catch-up contributions are in addition to the age 50+ catch-up deferrals, but are required to be "used" first if available. The 403(b) special catch-up formula may be available for employees with at least 15 years of service by the end of the calendar year, and includes a limitation of the least of:
The 457 special catch-up formula may be available for employees nearing the Normal Retirement Age (NRA) as defined by the plan, allowing a participant to additionally defer amounts that were considered unused (if they deferred under the deferral limit at the time) in prior years. Special rules apply to each of these catch up contribution types. Contact your consultant if your plan allows for these special catch-up contributions and you would like to discuss how they are calculated and used.
The compensation limit, increased to $265,000 for 2015, is the maximum amount defined contribution plans can consider when calculating or testing contributions. This tends to come into play most at year-end when the nondiscrimination testing is performed or annual contributions, like matching or non-elective contributions, are calculated. But this can affect your ongoing your payroll in two ways.
Employer Contributions as a Percentage of Compensation
The compensation limit most often impacts plans that calculate matching or non-elective contributions on a pay period basis. If you rely on payroll systems to calculate a matching or non-elective contribution, it is important that the system has a limit to those contributions on a year-to-date basis. While your payroll system may not have a way to cap the year-to-date compensation considered when calculating a contribution, you can often place a limit on the contribution total itself, which is dependent upon your formula. If you have a fixed non-elective contribution of 3% each pay period, or a matching contribution of 50% of the first 6% deferred, simply limit the contribution on an individual basis to $7,950 (3% of $265,000). The same applies if you have a tiered match, if your payroll system is set up to calculate and track this contribution - for example, a formula of 100% of the first 3% deferred plus 5% of the next 2% deferred (a basic safe harbor match), the maximum contribution is 4% of annual compensation, or $10,600 for 2015 for those earning at least $265,000. Below are some examples of ways to limit the employer contribution calculations in payroll.
Deferrals as a Percentage of Compensation
There can also be confusion when applying a participant's deferral election as a percentage of pay when an individual's compensation exceeds the annual limit. Most plans do not limit the compensation on which the deferrals can be calculated, but some are written that way. It is important to verify which way your plan is written to ensure compliance. If your plan document is written to base deferral elections on the first $265,000 earned in 2015, an individual earning over that amount in 2015 can only have deferrals deducted from pay until their compensation reaches that level (i.e. a 5% deferral election would be capped at $13,250 even though the participant hasn't reached the deferral limit). In most plans, though, this limit is not specified and the election applies to all compensation on an annual basis - meaning the deferral election applies without regard to the annual compensation limit and is only limited by the deferral limit for the year.
Informal IRS guidance recognizes this application3 and provides examples of these situations and clarification on the compensation limit (or lack thereof without a document provision to the contrary) when determining deferral deductions in a payroll. Multnomah Group can also help review and understand the limits applicable to your plan.
Most errors in calculations due to missed limits in payroll systems can be corrected in one fashion or another via the IRS Employee Plans Compliance Resolution System (EPCRS). However, these corrections can often pose additional administrative hassle if the excess amounts have already been deferred and/or deposited to the plan's trust. It's best to take the time at the beginning of each year to ensure your payroll system has up-to-date contribution and compensation limits and to enact procedures to monitor these limits if your payroll system cannot. Contact Multnomah Group if you would like to discuss the limits of your plan and employees, and options to utilize the tools available in your payroll system to avoid errors.
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Information herein is provided for general informational purposes and not intended to be completely comprehensive regarding the particular subject matter. Multnomah Group does not represent, guarantee, or provide any warranties (express or implied) regarding the completeness, accuracy, or currency of information or its suitability for any particular purpose. Receipt of information does not create an adviser-client relationship between Multnomah Group and you. Neither Multnomah Group nor our advisory affiliates provide tax or legal advice or opinions. You should consult with your own tax or legal adviser for advice about your specific situation.