The IRS just announced the 2012 retirement plan benefit limits and we’re finally going to see some (very) modest increases after 3 years of flat rates. What does it all mean for employer-sponsored retirement plans? This post analyzes the practical effects for both defined contribution (DC) and defined benefit (DB) plans, followed by a table summarizing the limit changes.
Changes affecting both DB and DC plans
- HCE compensation threshold increases from $110,000 to $115,000. For calendar year plans, this will first affect 2013 HCE designations because $115,000 will be the threshold for the 2012 “lookback” year. Slightly fewer participants will meet the HCE compensation criteria, which will have two direct outcomes:
- 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.
- Fewer HCEs means that there are fewer participants who must receive 401(k) deferral refunds if the plan fails the ADP test.
- Qualified compensation limit increases from $245,000 to $250,000. Highly-paid participants will now have more of their compensation “counted” towards qualified plan benefits and less towards non-qualified plans. This helps for both nondiscrimination testing as well as for benefits.
DC-specific increases and their significance
- Increase in annual DC 415 limit from $49,000 to $50,000 and 401(k) deferral limit from $16,500 to $17,000. A $1,000 increase to the overall DC limit and $500 increase to the deferral limit isn’t much, but it will allow participants to get a little more “bang” out of their DC plan. Since the 401(k) deferral limit counts towards the total DC limit, this means that an individual could potentially get up to $33,000 from profit sharing ($50K – $17K) if they maximize their DC plan deductions. Previously, their profit sharing limit would have been $32,500 ($49K – $16.5K)
- 401(k) “catch-up” limit remains at $5,500. Participants age 50 or older still only get a $5,500 catch-up opportunity. Combined with the new overall DC limit, they can effectively get a maximum DC deduction of $55,500 ($50K + $5.5K).
- The increase in the 401(k) deferral limit could be of limited value to companies whose 401(k) plans consistently fail the IRS Actual Deferral Percentage (ADP) test. In those situations, HCE deferrals are restricted to an amount below the statutory limit so a limit increase may not matter. One option to remedy the situation (though not without its costs) would be to adopt a safe-harbor plan design.
DB-specific increases and their significance
- DB 415 maximum benefit limit (the “dollar” limit) increases from $195,000 to $200,000. The primary consequence of this change is that individuals who have very large DB benefits (say, shareholders in a professional firm cash balance plan) could see a deduction increase if their benefits were previously constrained by the 415 dollar limit.
Below is a table summarizing the main changes to employer-sponsored retirement plan limits for 2012.