ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Virginia involved a question on 401(k) catch-up contributions. The advisor asked: “When does a 401(k) deferral become a catch-up contribution?”
Highlights of Discussion
An employee salary deferral becomes a catch-up contribution when it exceeds the lowest of the following three limits (See Treasury Regulation § 1.414(v)-1):
- A statutory or legal limit (as explained below);
- A plan-imposed limit stated in the plan document; and
- The plan’s actual deferral percentage (ADP) limit on salary deferrals.
Salary deferrals above the lowest of these three limits will be considered catch-up contributions up to the annual catch-up maximum amount for a 401(k) plan (i.e., $7,500 for 2023).
Examples of a statutory or legal limit include the IRC Sec. 402(g) limit (i.e., 22,500 for 2023) or the IRC Sec. 415(c) annual additions limit (i.e., 100% of a participant’s compensation up to $66,000 for 2023). An example of a plan limit would be if the plan document were to specify that employee salary deferrals are limited to 10% of a participant’s annual compensation. Finally, a plan’s ADP limit on employee salary deferrals is determined by comparing the salary deferrals of the highly compensated employees (HCEs) to those of the nonhighly compensated employees (NHCEs) and limiting deferrals for HCEs to a level that allows the plan to satisfy the ADP nondiscrimination test.
Example: Rowan is a 55-year-old HCE who participates in a 401(k) plan he established for his firm. His compensation for the year is $100,000. The maximum IRC Sec. 402(g) limit for the year is $22,500. The terms of the 401(k) plan limit employee salary deferrals to 10% of compensation or, in Rowan’s case, $10,000. The plan administrator determines the salary deferral ADP limit for the year is $8,000. The lessor of $22,500, $10,000 or $8,000 is $8,000. Therefore, any salary deferral Rowan would make above $8,000 (up to a maximum catch-up limit of $7,500) would be considered a catch-up contribution.
There may be more to catch-up contributions than the average person realizes. An employee salary deferral becomes a catch-up contribution when it exceeds the lowest of a legal limit, a plan-imposed limit or the ADP limit.
Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.
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