Various changes in tax law have had a positive impact on how much Americans can save in qualified retirement plans. By reviewing the different types of plan designs before the end of 2006, CPAs and their clients may be better able to capitalize on some of these changes. Here are some points to consider:
Elective 401(k) deferrals. The maximum elective contribution per employee in the 2006 calendar year is $15,000, even if the plans are from different employers.
Catch-up contributions. Employees who will reach age 50 or older by the end of the plan year can add a catch-up contribution of $5,000 to their 401(k) elective deferrals.
Annual additions limit for defined contribution plans. Annual additions—including employer contributions, employee contributions and forfeitures—are limited to the lesser of 100% of compensation or $44,000. The catch-up contribution is not included in this limit.
Annual compensation limit. The eligible compensation limit in 2006 was $220,000. If services are rendered by a husband and wife, consider balancing their compensation (as long as it is reasonable and customary) to increase their overall retirement contribution.
Highly compensated employee limit. Employees earning $100,000 or more may be excluded from the plan. This may work well in a professional organization, which could cover non-highly-compensated employees along with the partners, leaving out highly-compensated managers or supervisors.
Maximum annual retirement benefit. The annual limit for defined benefits is $175,000 for retirement ages 62–65.
Tax credit for new plans. A three-year tax credit of 50% of the first $1,000 of start-up costs ($500 maximum) is available to employers with fewer than 100 employees that cover at least one non-highly-compensated employee. Eligible expenses include fees to establish the plan, administrative fees and costs incurred to educate employees about the plan.
The Roth 401(k). A Roth 401(k) plan may be added to a traditional 401(k) plan, allowing participants to make after-tax contributions. Income limits do not apply. Employer matching contributions must continue to be made on a pre-tax basis. Plan sponsors must amend the plan to include the provision.
One-person plans. Employee deferrals are not included in the deduction limit, though they are included in the annual addition limit. Consider a uni-401(k) plan or a defined benefit plan with a 401(k) to maximize contributions. For example, in 2006 a 50-year-old business owner earning $50,000 of W-2 compensation could contribute $32,500 to a uni-401(k) plan (25% 3 $50,000 5 $12,500, plus $15,000 employee deferrals plus $5,000 catch-up for age 50). The same business owner making $220,000 could contribute only $49,000 to a uni-401(k) plan (annual addition limit of $44,000 plus catch-up of $5,000). A defined benefit plan with retirement age 60 would allow for contributions of $160,000 or more plus $20,000 for 401(k) with catch-up.
Comparability profit-sharing plans. Consider a comparability plan for clients who would like to keep the contribution discretionary and to have different contribution percentages for different categories of participants.
Safe-harbor plans. These plans eliminated many of the issues with testing associated with 401(k) plans. Consider them if you have bumped into limits to the levels of contributions of highly compensated participants. Certain structures permit a double use of a safe-harbor contribution, enabling reduced levels of profit-sharing dollars to achieve maximum contribution levels. Safe-harbor elections for 2007 must be made prior to December 1, 2006.
Source: Stuart L. Youngentob, CPA, JD, Arkin Youngentob Associates LLC, Bethesda, Md., and Carolyn Lloyd-Cohen, CLU, ChFC, Preferred Pensions LLC., Clifton, N.J., National Financial Partners Affiliated Firms.