IRS announces 401(k) limit increases to $20,500

The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan has been increased from $19,500 to $20,500 beginning with the 2022 calendar year.

Additionally, the income ranges for determining eligibility to make deductible contributions to traditional Individual Retirement Arrangements (IRAs), to contribute to Roth IRAs, and to claim the Saver’s Credit have also all increased for 2022.

Below are the updated phase-out ranges for IRA contributions in 2022:

Single Taxpayers

For single taxpayers covered by a workplace retirement plan (even if only for a portion of the year), the phase-out range is increased to $68,000 to $78,000, up from $66,000 to $76,000.

Married Filing Jointly Taxpayers

If the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is increased to $109,000 to $129,000, up from $105,000 to $125,000.

If the spouse making the IRA contributor is not covered by a workplace retirement plan but is married to someone who is covered, the phase-out range is increased to $204,000 to $214,000, up from $198,000 to $208,000.

Married Filing Separately Taxpayers

If a taxpayer is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Roth IRAs

The income phase-out range for taxpayers making contributions to a Roth IRA is increased to $129,000 to $144,000 for single and head of household taxpayers, up from $125,000 to $140,000. For married couples filing jointly, the income phase-out range is increased to $204,000 to $214,000, up from $198,000 to $208,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Simple IRAs

The amount individuals can contribute to their SIMPLE retirement accounts is increased to $14,000, up from $13,500.

Key employee contribution limits that remain unchanged

The limit on annual contributions to an IRA (Roth or Traditional) remains unchanged at $6,000. The IRA catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000, for a maximum contribution amount of $7,000.

The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $6,500. Therefore, participants in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan who are 50 and older can contribute up to $27,000, starting in 2022. The catch-up contribution limit for employees aged 50 and over who participate in SIMPLE plans remains unchanged at $3,000.

Details on these and other retirement-related cost-of-living adjustments for 2022 are in Notice 2021-61, available on IRS.gov.

The SECURE Act – What You Need to Know

Congress recently passed—and the President signed into law—the SECURE Act, landmark legislation that affects the rules for creating and maintaining employer-provided retirement plans. Whether you currently offer your employees a retirement plan, or are planning to do so, you should consider how these new rules may affect your current retirement plan (or your decision to create a new one).

Here is a look at some of the more important elements of the SECURE Act that have an impact on employer-sponsors of retirement plans. The changes in the law apply to both large employers and small employers, but some of the changes are especially beneficial to small employers. However, not all of the changes are favorable, and there may be steps you could take to minimize their impact. Please give me a call if you would like to discuss these matters.

It is easier for unrelated employers to band together to create a single retirement plan. A multiple employer plan (MEP) is a single plan maintained by two or more unrelated employers. Starting in 2021, the new rules reduce the barriers to creating and maintaining MEPs, which will help increase opportunities for small employers to band together to obtain more favorable investment results, while allowing for more efficient and less expensive management services.

New small employer automatic plan enrollment credit. Automatic enrollment is shown to increase employee participation and retirement savings. Starting in 2020, the new rules create a new tax credit of up to $500 per year to employers to defray start-up costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. The credit is in addition to an existing plan start-up credit, and is available for three years. The new credit is also available to employers who convert an existing plan to a plan with an automatic enrollment design.

Increased credit for small employer pension plan start-up costs. The new rules increase the credit for plan start-up costs to make it more affordable for small businesses to set up retirement plans. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit on the credit to the greater of

  1. $500, or
  2. The lesser of:
    1. $250 multiplied by the number of nonhighly compensated employees of the eligible employer who are eligible to participate in the plan, or
    2. $5,000.

The credit applies for up to three years.

Expand retirement savings by increasing the auto enrollment safe harbor cap. An annual nondiscrimination test called the actual deferral percentage (ADP) test applies to elective deferrals under a 401(k) plan. The ADP test is deemed to be satisfied if a 401(k) plan includes certain minimum matching or non-elective contributions under either of two safe harbor plan designs and meets certain other requirements. One of the safe harbor plans is an automatic enrollment safe harbor plan.

Starting in 2020, the new rules increase the cap on the default rate under an automatic enrollment safe harbor plan from 10% to 15%, but only for years after the participant’s first deemed election year. For the participant’s first deemed election year, the cap on the default rate is 10%.

Allow long-term part-time employees to participate in 401(k) plans. Currently, employers are generally allowed to exclude part-time employees (i.e., employees who work less than 1,000 hours per year) when providing certain types of retirement plans—like a 401(k) plan—to their employees. As women are more likely than men to work part-time, these rules can be especially harmful for women in preparing for retirement.

However, starting in 2021, the new rules will require most employers maintaining a 401(k) plan to have a dual eligibility requirement under which an employee must complete either a one-year-of-service requirement (with the 1,000-hour rule), or three consecutive years of service where the employee completes at least 500 hours of service per year. For employees who are eligible solely by reason of the new 500-hour rule, the employer will be allowed to exclude those employees from testing under the nondiscrimination and coverage rules, and from the application of the top-heavy rules.

Looser notice requirements and amendment timing rules to facilitate adoption of nonelective contribution 401(k) safe harbor plans. The actual deferral percentage nondiscrimination test is deemed to be satisfied if a 401(k) plan includes certain minimum matching or nonelective contributions under either of two plan designs (referred to as a “401(k) safe harbor plan”), as well as certain required rights and features, and satisfies a notice requirement. Under one type of 401(k) safe harbor plan, the plan either

  1. Satisfies a matching contribution requirement, or
  2. Provides for a nonelective contribution to a defined contribution plan of at least 3% of an employee’s compensation on behalf of each nonhighly compensated employee who is eligible to participate in the plan.

For plan years beginning after Dec. 31, 2019, the new rules change the nonelective contribution 401(k) safe harbor to provide greater flexibility, improve employee protection, and facilitate plan adoption. The new rules eliminate the safe harbor notice requirement, but maintain the requirement to allow employees to make or change an election at least once per year. The rules also permit amendments to nonelective status at any time before the 30th day before the close of the plan year. Amendments after that time are allowed if the amendment provides

  1. A nonelective contribution of at least 4% of compensation (rather than at least 3%) for all eligible employees for that plan year, and
  2. The plan is amended no later than the last day for distributing excess contributions for the plan year (i.e., by the close of following plan year).

Expanded portability of lifetime income options. Starting in 2020, the new rules permit certain retirement plans to make a direct trustee-to-trustee transfer to another employer-sponsored retirement plan, or IRA, of a lifetime income investment or distributions of a lifetime income investment in the form of a qualified plan distribution annuity, if a lifetime income investment is no longer authorized to be held as an investment option under the plan. This change permits participants to preserve their lifetime income investments and avoid surrender charges and fees.

Qualified employer plans barred from making loans through credit cards and similar arrangements. For loans made after Dec. 20, 2019, plan loans may no longer be distributed through credit cards or similar arrangements. This change is intended to ensure that plan loans are not used for routine or small purchases, thereby helping to preserve retirement savings.

Nondiscrimination rules modified to protect older, longer service participants in closed plans. Starting in 2020, the nondiscrimination rules as they pertain to closed pension plans (i.e., plans closed to new entrants) are being changed to permit existing participants to continue to accrue benefits. The modification will protect the benefits for older, longer-service employees as they near retirement.

Plans adopted by filing due date for year may be treated as in effect as of close of year. Starting in 2020, employers can elect to treat qualified retirement plans adopted after the close of a tax year, but before the due date (including extensions) of the tax return, as having been adopted as of the last day of the year. The additional time to establish a plan provides flexibility for employers who are considering adopting a plan, and the opportunity for employees to receive contributions for that earlier year.

New annual disclosures required for estimated lifetime income streams. The new rules (starting at a to-be-determined future date) will require that plan participants’ benefit statements include a lifetime income disclosure at least once during any 12-month period. The disclosure will have to illustrate the monthly payments the participant would receive if the total account balance were used to provide lifetime income streams, including a qualified joint and survivor annuity for the participant and the participant s surviving spouse and a single life annuity.

Fiduciary safe harbor added for selection of annuity providers. When a plan sponsor selects an annuity provider for the plan, the sponsor is considered a plan “fiduciary,” which generally means that the sponsor must discharge his or her duties with respect to the plan solely in the interests of plan participants and beneficiaries (this is known as the “prudence requirement”).

Starting on Dec. 20, 2019 (the date the SECURE Act was signed into law), fiduciaries have an optional safe harbor to satisfy the prudence requirement in their selection of an insurer for a guaranteed retirement income contract, and are protected from liability for any losses that may result to participants or beneficiaries due to an insurer’s future inability to satisfy its financial obligations under the terms of the contract. Removing ambiguity about the applicable fiduciary standard eliminates a roadblock to offering lifetime income benefit options under a plan.

Increased penalties for failure-to-file retirement plan returns. Starting in 2020, the new rules modify the failure-to-file penalties for retirement plan returns.

The penalty for failing to file a Form 5500 (for annual plan reporting) is changed to $250 per day, not to exceed $150,000.

A taxpayer’s failure to file a registration statement incurs a penalty of $10 per participant per day, not to exceed $50,000.

The failure to file a required notification of change results in a penalty of $10 per day, not to exceed $10,000.

The failure to provide a required withholding notice results in a penalty of $100 for each failure, not to exceed $50,000 for all failures during any calendar year.

What Is The True Cost Of An Early Withdrawal From Your 401(k)?

Tapping into your 401(k) as if it were a rainy day fund should always be a last resort. Many individuals are not aware of the negative tax implications of an early withdrawal from a retirement account. Before we go more in-depth, here are the key take-aways:

  • Borrowing or taking early withdrawals from your 401(k) can result in large tax burdens in addition to tax penalties
  • While exceptions exist, the most common withdrawals (education or buying a home) are still subject to tax penalties
  • If you borrow from a 401(k), loan funds will not grow in value and will automatically be converted to a withdrawal if you leave your employer, voluntarily or involuntary, while the loan is still outstanding.

401(k) Penalties

The penalties for early withdrawals from your 401(k) are assessed at a flat 10% rate on the total distribution. So, if you take a $50,000 distribution from your 401(k) before reaching 59 ½ years of age, you will owe a penalty of $5,000 before even paying any federal income tax on this amount. Remember, most 401(k) contributions are pre-tax deferrals, meaning you receive a deduction in the year you contribute, but you eventually pay tax on the withdrawals and earnings when you retire – hopefully in a lower tax bracket.

Exceptions to the Rules

There are exceptions to the 10% early withdrawal penalty mentioned above, but they are typically rare situations. Distributions made because of total and permanent disability and distributions made to cover medical expense that are deductible and exceed 10% of your adjusted gross income whether or not you itemize your deductions for the year. All exceptions can be found here.

401(k) Loans

Many employers and plan administrators offer the opportunity to borrow funds from your 401(k). Loans from your 401(k) can have some upside, such as low interest rates and not showing on your credit report, but there are also some downsides. Borrowed funds do not participate in the market or growth of your retirement account.

Quite possibly the biggest risk with loans is the immediate payback clause if you are laid off, quit, or are terminated as an employee. If you do not payback the full amount of the outstanding loan, the outstanding balance will be considered a distribution and no further repayment would be required. Not only does this subject you to the 10% early withdrawal penalty, but the withdrawal will be fully taxable at your marginal rate. Since this would be considered income, it can catapult you into a higher tax bracket, resulting in higher taxes on all your income.

Here’s a brief example of how this might look. Let’s say you are a married taxpayer with W-2 income of $150k. Based on 2017 estimated tax brackets, you would be in the 25% tax bracket. If you had a $50k loan from your 401(k) and were unexpectedly laid off, you would have to pay that loan back immediately. If you couldn’t afford to pay this loan back immediately, that $50k would become taxable in 2017, pushing you into the 28% bracket. The tax on that $50k distribution is now $14k PLUS the early withdrawal penalty of $5k, costing you a total of $19k. To summarize, a $50k early withdrawal would only leave you with $31,000!