Although remaining unchanged for 2021, HR professionals should still 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.
According to Fidelity Investments, employees’ average 401(k) contribution rate
remained steady at 8.9 percent of their pay during the first quarter of 2020, despite significant market volatility due to the pandemic and economic downturn.
With the annual increase in the employee contribution limit, a good message for plan participants is that “increasing your contribution rate, even by 1 percent, can make a big difference in your long-term retirement savings,” said Kevin Barry, president of workplace investing at Fidelity. “What may seem like a small amount today can have a significant impact on your account balance in 10 or 20 years.”
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.
401(k) accounts could fund retirements closer to the level of traditional pensions plans if participants contributed more, according to Sit. “It takes about 15-20 percent of your pay to get to the level a typical pension plan once paid,” he noted. For employees to achieve the same level of retirement income, they will need to target their contributions at that level, counting their employer match, he advised.
Complying with Contribution Limits
IRS records show that the vast majority of employees comply with annual limits on the amount of compensation that they can contribute to their 401(k) plans, according to a 2018 report by the Treasury Inspector General for Tax Administration. Nonetheless, the inspector general
identified two areas in which compliance could be improved:
- 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,” noted 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.”
- 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.”
A Roth 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.
Many plans allow participants 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 2021 participant contribution limit of $19,500 (or $26,000 after age 50) is exceeded, up to the “all sources” contribution limit of $58,000 (or $64,500 after age 50).
If the plan document allows after-tax contributions to a traditional 401(k), then by following the correct steps employees can convert these contributions to Roth dollars within the plan, or
Defined Benefit Plan Limits
Sponsors of defined benefit pension plans should note that the IRS announced the following COLAs under tax code Section 415, also taking effect on Jan. 1:
Annual benefit limit. The maximum annual benefit that may be provided through a defined benefit plan remained unchanged at
Separation from service. For a participant who separated from service before Jan. 1, 2021, the annual benefit limit for defined benefit plans is computed by multiplying the participant’s compensation limit, as adjusted through 2020, by
1.0122. This is a slight decrease from the previous year, when the participant’s compensation limit, as adjusted through 2019, was multiplied by 1.0176.
Separately, the federal Pension Benefit Guaranty Corp., which insures private-sector defined benefit pension plans,
posted 2021 premium rates for single-employer and multiemployer pension plans.
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Other Employer Plans
IRS Notice 2020-79 also provided adjusted limits and thresholds for other workplace retirement plans:
SIMPLE (savings incentive match plan for employees of small employers) retirement accounts, the maximum contribution limit remains at $13,500. The SIMPLE plan catch-up contribution limit remains
For simplified employee pensions (SEPs), the minimum compensation threshold is increased to
$650 from $600. The SEP maximum compensation limit rises to
$290,000 from $285,000.
401(k) plans offered by private employers and 403(b) plans, designed for tax-exempt and nonprofit organizations such as schools, hospitals and religious groups, meet specifications laid out in Section 401(a) of the U.S. tax code and are therefore known as tax-qualified plans. Both plan types share the same tax advantages, contribution limits, Roth options and early withdrawal penalties, although some of the rules regarding plan administration and compliance with the Employee Retirement Income Security Act (ERISA) differ.
But 457 plans, offered by state and local public employers and some nonprofit employers, are considered nonqualified retirement plans and are not governed by ERISA. In addition, 457 plans differ from 401(k) and 403(b) plans with regard to catch-up contributions, early withdrawals and hardship distributions.
If an employee has both a 401(k) and 403(b) retirement plan, whether from the same or different employers, their combined contributions to both plans together are capped at $19,500 for 2021 plus the $6,500 catch-up contribution for participants who are age 50 or older, while employer-plus-employee contributions top off at $58,000 for both plans combined.
However, the IRS allows participants who contribute to a 401(k) and a 457 plan at the same time to contribute the maximum amount to both plans separately, and the same holds for employer-plus-employee limits. Likewise, participants with a 403(b) plan and a 457 plan can contribute to each separately up to each plan’s annual limit.
The limit on annual contributions to an IRA remains unchanged at
$6,000. The additional catch-up contribution limit to an IRA for individuals age 50 and over remains
Although personal IRAs are not employer plans, the amount that account holders 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 eligibility to contribute to Roth IRAs, increased for 2021 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 they or their spouse was covered by a retirement plan at work, the deduction may be phased out until it is eliminated, depending on filing status and adjusted gross income (AGI):
For single people covered by a workplace retirement plan, the IRA phase-out range is $66,000 to $76,000, up from $65,000 to $75,000.
For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is
$105,000 to $125,000, up from $104,000 to $124,000.
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
$198,000 and $208,000, up from $196,000 and $206,000.
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 2021 AGI phase-out range for taxpayers contributing to a Roth IRA are:
For singles and heads of household, the income phase-out range is
$125,000 to $140,000, up from $124,000 to $139,000.
For married couples filing jointly, the income phase-out range is
$198,000 to $208,000, up from $196,000 to $206,000.
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.
The income limit for the Saver’s Credit (also known as the Retirement Savings Contributions Credit) for low- and moderate-income workers is
$66,000 for married couples filing jointly, up from $65,000;
$49,500 for heads of household, up from $48,750; and
$33,000 for singles and married individuals filing separately, up from $32,500.
Related SHRM Articles:
Viewpoint: Employers Need to Reinvent Retirement-Savings Match,
SHRM Online, October 2020
Viewpoint: How to Minimize the Risk of Retirement Plan Litigation,
SHRM Online, September 2020
When Employers Must Cut Their 401(k) Contributions to Stay Afloat, SHRM Online, March 2020
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