'Catch-up' contribution for those 50+ stays at $6,000, while contribution limit from all sources hits $55,000
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:
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.
2018 Income Tax Brackets and Retirement Plans
The IRS issued income tax bracket adjustments for tax year 2018 on Oct. 19.
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.
ARoth 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.
Some plan sponsors will 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).
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. This approach gives heavy savers who contribute up to the standard limit more access to Roth contributions than would be the case if they relied solely on direct Roth 401(k) or Roth IRA 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 1.0196. 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."
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.
IRA Deduction Phase-Out Ranges
- The limit on annual contributions to an IRA will stay unchanged at $5,500. The additional catch-up contribution limit for individuals ages 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.
- 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 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.
- 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 a married individual filing a separate returnwho makes contributions to a Roth IRA, the phase-out range is not subject to an annual cost-of-living adjustment and remains$0 to $10,000.
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Source: Society for Human Resource Management (SHRM)