2019 Defined Contribution Plan Limits

Complying with Contribution Limits

• Some 401(k) plans did not prevent taxpayers from exceeding the annual limit.

• Some employees exceed annual limits when contributing to multiple 401(k) plans.

The findings suggest that employers ensure that their payroll systems don’t accept participant contributions that exceed the annual dollar limit, and that employers educate plan participants who may be holding more than one job that the annual limit applies to total contributions to all 401(k) plans.

“Over-contribution means having to deal with a long series of headaches to make up for the mistake,” blogged Evan Ross, content marketing manager at ForUsAll, a provider of 401(k) plan services for small companies. “This usually results in unhappiness all around. Employees face a potentially significant financial inconvenience, and as plan administrator, it’s mostly your problem to deal with.”

He advised:

• Warning employees with multiple plans that they can be more vulnerable to accidental over-contribution..
• Adding validation checks to payroll systems, to prevent over-contributions from happening so that “you don’t have to spend your valuable time on fixing mistakes months down the line.”

Annual Limit as a Contribution Goal

Those who have not been contributing enough per paycheck to reach the annual cap and who can afford to do so can increase their contributions before the end of the year so that they reach the full annual limit.

Conversely, participants 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 per-paycheck deferrals, unless the plan sponsor has agreed to “make whole” or “true up” participants who max out their annual contributions prior to their final paycheck.

The overall average employee 401(k) contribution rate reached 8.7 percent of pay during the third quarter of 2018, revealed a client survey by Fidelity Investments, among the largest 401(k) plan administrators. The average 401(k) balance reached an all-time high balance of $106,500. But often employees contribute well below the average and have much smaller account balances as a resut.

Many 401(k) participants mistakenly believe they only need to contribution up to the maximum company match. “Out of all the 401(k) misconceptions I hear employees talk about, this is the most frequent,” noted Robert Lawton, president of Lawton Retirement Plan Consultants in Milwaukee. “Many plan participants believe their employer is sending them a message on how much to contribute.”

Plans commonly require workers to save 6 percent to receive the full employer-matching contribution. However, many studies indicate that participants should contribute at least 15 percent of their pay each year to their 401(k) account.

Research published last year by plan administrator Voya Financial showed that suggesting that employees contribute between 7 percent and 10 percent of pay didn’t decrease plan enrollment when compared to a 6 percent control rate. “While there has been significant progress in the adoption of automatic plan features, a natural next step [to encourage higher savings rates] could be for employers to consider substantially increasing the most commonly used default rate today,” which is 3 percent in automatic enrollment plans, said Richard Mason, head of behavioral finance at Voya Financial.

Nondiscrimination Tests Affected

• The actual contribution percentage (ACP) test, the actual deferral percentage (ADP) test and the coverage test compare the benefits of highly compensated employees compared to nonhighly compensated employees.

• The top-heavy test compares the plan benefits of key employees compared to nonhighly compensation employees. Key employees include officers of the company who, in 2019, earn at least $180,000.

The annual ceiling on employee compensation that’s used to calculate employee-deferral and employer-matching contributions is increasing to $280,000 from $275,000. “The pay cap increase will lessen the impact on annual nondiscrimination testing of maximum deferrals taken by high-earners,” at least somewhat, said Brian Donohue, a partner in the Chicago office of October Three Consulting, a retirement plan advisory firm.

Another factor that could make passing nondiscrimination testing easier is that the dollar limit used to define HCEs will rise next year to $125,000 from $120,000. When the HCE compensation threshold doesn’t increase to keep pace with employee salary increases, more participants become classified as HCEs, causing plans to fail nondiscrimination tests.

“It’s nice to have an increase after several years of a stagnant $120,000 limit” for the HCE threshold, stated Van Iwaarden Associates, a retirement plan services firm in Minneapolis and San Francisco. “Plans may see marginally better nondiscrimination testing results (including ADP results) if there are fewer HCEs. It could potentially make a big difference for smaller plans that were very close to failing the tests.”

Also, “fewer HCEs means that there are fewer participants who must receive 401(k) deferral refunds if the plan fails the ADP test,” the firm noted.

While the HCE threshold for 2019 will increase for the first time in four years, “this could improve nondiscrimination testing results but won’t have an impact until next year,” since compensation for HCEs is based on a lookback year, Donohue explained. Because of the lookback procedure for determining HCE status, 2020 HCEs are determined based on whether their 2019 compensation is above the $125,000 threshold, Van Iwaarden also noted.

In addition, most plans allow participants to start making catch-up contributions in the calendar year in which they reach age 50. Catch-up contributions are not included in ADP testing, and thus catch-up contributions “can be used to enable higher total contributions and, as necessary, to re-characterize contributions that would otherwise be returned to participants due to IRS limits,” said Jack Towarnicky, executive director at Plan Sponsor Council of America, an employers group.

401(k) After-Tax Contributions

Many plans allow particpants to convert 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 2019 participant contribution limit of $19,000 (or $25,000 after age 50) is exceeded, up to the “all sources” contribution limit of $56,000 (or $62,000 after age 50).

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.

Defined Benefit Plan Limits

• Annual benefit limit. The maximum annual benefit that may be provided through a defined benefit plan rises to $225,000 from $220,000.

• Separation from service. For a participant who separates from service before Jan. 1, 2019, the annual benefit limit for defined benefit plans is computed by multiplying the participant’s compensation limit, as adjusted through 2018, by 1.0264. This is an increase from the previous year, when the participant’s compensation limit, as adjusted through 2017, was multiplied by 1.0197.

Separately, the federal Pension Benefit Guaranty Corp., which insures private-sector defined benefit pension plans, posted 2019 premium rates for single-employer and multiemployer pension plans.

In Notice 2018-02, the IRS updated the mortality tables that defined benefit pension sponsors can use, beginning in 2019, to set minimum funding, maximum benefits and minimum lump sums.

SIMPLES, SEPs and ESOPs

• For SIMPLE (savings incentive match plan for employees of small employers) retirement accounts, the maximum contribution limit increased to $13,000from $12,500. The SIMPLE plan catch-up contribution limit remains $3,000.

• For simplified employee pensions (SEPs), the minimum compensation threshold remains unchanged at $600. The SEP maximum compensation limit rises to $280,000from $275,000.

• For employee stock ownership plans (ESOPs), the maximum account balance in the plan subject to a five-year distribution period will increase to $1,130,000 from $1,105,000, while the dollar amount used to determine the lengthening of the five-year distribution period rises to $225,000 from $220,000.

IRAs

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 2019, 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 2019 are:

• For single taxpayers covered by a workplace retirement plan, the phase-out range is $64,000 to $74,000, up from $63,000 to $73,000.

• For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $103,000 to $123,000, up from $101,000 to $121,000.

• 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 $193,000 and $203,000, up from $189,000 and $199,000.

• 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 $122,000 to $137,000, up from $120,000 to $135,000.

• For married couples filing jointly, the income phase-out range is $193,000 to $203,000, up from $189,000 to $199,000.

• 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.

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