The IRS has just issued its Fall 2009 edition of employee plans news. Among the helpful guidance provided in this edition is a discussion of the numerous limits imposed by the Internal Revenue Code on the amount of the contributions which may be made under a 401(k) plan, or another qualified defined contribution retirement plan, and how these limits interact.
According to the discussion, some of these limits are:
• Annual additions to a participant’s account under §415(c);
• Elective deferrals under §401(a)(30) (referencing §402(g));
• Catch-up contributions under §414(v);
• Annual compensation under §401(a)(17); and • Deductible contributions by the employer under §404(a)(3).
The discussion notes that some of these limits are subject to annual cost-of-living adjustments. For 2009, the maximum amount of annual additions which may be made to a participant’s account under §415(c) is the lesser of 100% of the participant’s compensation or $49,000. This limit applies to:
• Employer contributions (matching and nonelective);
• Employee contributions (pre-tax elective deferrals and designated Roth contributions, other than catch-up contributions, and after-tax); and • Forfeitures.
Other dollar limits for 2009 are (1) $16,500 under §402(g) for pre-tax elective deferrals and designated Roth contributions, (2) $5,500 under §414(v) for “catch-up” elective deferral contributions made by participants who are age 50 or older by the end of the year and (3) $245,000 under §401(a)(17) on the amount of a participant’s annual compensation that may be taken into account by the plan.
The IRS discusses how some of these limits interact. Under §404(a)(3), an employer may deduct employer contributions up to 25% of the total compensation, as limited by §401(a)(17), paid to all benefitting plan participants. Salary reduction contributions can be deducted on top of this 25% limit. The amount of compensation, as limited by §401(a)(17), which is used to calculate the 25% of compensation limit includes salary reduction contributions and certain other employee benefits. For SIMPLE 401(k) plans, the deductible amount is the required §401(k)(11) contribution. Employers can only deduct amounts up to the §415(c) limit described above.
Further, if the plan allows a participant to make catch-up contributions, then the §402(g) limit is increased for that participant by the amount of the allowed catch-up contribution under §414(v), but cannot exceed 100% of the employee’s compensation. Catch-up contributions, if permitted by the plan, would allow a maximum contribution of $54,500 ($49,000 plus $5,500 catch-up contributions) to be made to an eligible participant’s account for 2009, limited only by the participant’s compensation and the employer’s deductible limit as discussed below.
The IRS indicates that confusion may arise on how to reconcile the limits under §401(a)(17), §415(c) and §402(g) when an employee’s annual compensation exceeds the current §401(a)(17) limit. For example, can a 40-year-old employee earning $30,000 per month (annual compensation of $360,000) who elects to defer a flat dollar amount of $1,375 per month ($16,500 for the year) in 2009 to his or her 401(k) plan continue to make elective deferrals after September, at which time his or her year to-date compensation exceeds $245,000? The answer is yes, because the plan is not required to determine the limit to a participant’s compensation under §401(a)(17) based on the earliest payments of compensation during a year. Unless the plan’s terms provide otherwise, the $16,500 §402(g) elective deferral limit is applied uniformly to the $245,000 §401(a)(17) limit on the compensation that the employee receives throughout the year, regardless of whether deferrals are expressed as a dollar amount or a percentage of compensation in the employee’s salary reduction agreement.
The employer’s tax deduction, as limited by §404(a)(3), is also limited by the §401(a)(17) limit on compensation and the §415(c) limit on annual additions. As such, the maximum deduction allowed, other than for SIMPLE 401(k) plans, is the lesser of:
• 25% of the total compensation, as limited by §401(a)(17), of all benefitting plan participants; or • the maximum combined §415(c) dollar limit for all benefitting plan participants.
The IRS points out that failing to comply with any of the above mentioned limits, except the §404(a)(3) limit, can lead to plan disqualification. Information on correcting plan errors may be found on the IRS’s Employee Plans Compliance Resolution System (EPCRS) Web page.