Some Context Around 2015 Deferral Limit Increases

Kevin Crain is a 30-year veteran of the financial services industry, currently serving as a senior relationship executive for Bank of America Merrill Lynch. In that time he has seen many announcements from the Internal Revenue Service (IRS), like the one issued last week, updating key deferral and benefit limits for qualified employer-sponsored retirement plans.

As the IRS explains, the elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan has increased from $17,500 to $18,000 for the 2015 plan year. The catch-up contribution limit for employees aged 50 and over also increased $500, from $5,500 to $6,000. Effective January 1, 2015, the limitation on the annual benefit under a defined benefit plan under Section 415(b)(1)(A) remains unchanged at $210,000.

Crain says the relatively small increase in maximum deferrals on the defined contribution (DC) side is important for several reasons.

“First, it’s pretty clear that anything the government can do that will reinforce the importance of saving more in the employer-based retirement system is a good thing,” Crain notes. “So even if the increase was relatively small for the maximum general elective deferral—simply the fact that it’s gone up is an important thing and the industry should indeed be taking note.”

Crain suggests plan sponsors and advisers can use the deferral limit increase as the basis for a round of participant mailings—reminding participants of the importance of saving as much as possible as early as possible.

“I think there is a lot of value in the broad message that the ability to save at the maximum has gone up, and that the gross number is now $18,000 a year,” he says. “If we can get people to think about that number, to know what it represents and to start moving towards it, that’s important.”

Crain says such a message is probably more important this year than in some years past—due to pending tax reform proposals that seek to raise revenues by potentially cutting back on tax breaks for workplace retirement savers (see “Expect Some Tax Reform Effect on Retirement Plans”). With this story brewing in the background, it’s important for participants to know that the government looks favorably on the use of DC plans as a retirement savings vehicle, Crain says.

“The other way I look at this is, if you look back just five years or so, we were at $16,500 for the annual deferral limit,” Crain notes. “So going up to $18,000 is not a huge increase over last year, but if you think about that extra $1,500 a year for someone’s long-term savings, it’s a big deal when you consider the additional accumulative power over the course of their career.”

There’s a similar and perhaps even more important story to tell about the catch-up contribution increase, Crain says.

“If you look closer at the catch-up contribution maximum increase, which grew from $5,500 to $6,000, that’s actually almost a 10% jump in terms of an annual increase,” Crain notes. “Clearly that’s a big increase for a single year, especially given where we are on inflation.”

Crain observes that, with the latest increases in normal and catch-up deferrals, a qualified plan participant can now divert $24,000 of their annual income into a DC plan. He admits that most participants don’t save at a rate sufficient enough to hit the maximum, but it’s still an important signal that the catch-up limit was increased.

“So even if an individual is late to start their retirement savings, there is still some hope for them, especially if they’re coming into their own as a wage earner,” Crain says. “They’ll have 15 years before retirement to save at a pretty significant maximum, or perhaps even longer if you look at the new mortality tables coming out. That’s a great thing. Of course saving earlier is going to be better, but I definitely see this as a move to help those savers who have fallen behind.”

“As the catchup contribution limit grows and people start living longer, I think that actually bodes well for the retirement picture,” Crain adds. “A few decades ago we would have expected someone at age 50 to have 10 more years of working income to count on. Today we understand that’s probably going to be closer to 15 more years in the workforce. And in another decade, maybe we can expect people to work to 70. So that would be 20 years to save at $24,000 a year for some people. In this context the increases we are talking about take on even more meaning.”

Crain says it’s also important to note that the maximum benefit limit for defined benefit (DB) plan participants was not increased for 2015. Additionally, a number of important deferral limits impacting savers using individual retirement accounts (IRAs) were also kept the same—suggesting the IRS is paying particular attention to the growing importance of the DC universe as America’s primary retirement system.

“I think that if you look at the way limits for DBs and IRAs really didn’t change this year, it’s telling,” he says. “Of course, you can’t read too much into the intentions of the IRS, but that being said there does seem to be more emphasis and more push around the DC side of the retirement system. People are getting a greater ability to save successfully in their 401(k)s, and the IRS wants to underscore the value of employee individualism for retirement savings. So that translates to them being somewhat more attentive to the 401(k) system.”