IIt is likely the IRS’ qualified retirement plan contribution limits are not keeping up with many Key Employees’ retirement needs. Although indexed to inflation, the contribution limits for employees that participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan simply cannot keep up with Key Employee retirement needs.
New IRS Limits in 2020
In 2020, the contribution limit for employees who participate in these qualified plans increased from $19,000 to $19,500. Worse, if you are age 50 or over, the catch-up contribution limit is only $6,500 in 2020.
Similarly, the § 415(c)(1)(A) total contribution limit applicable to these retirement plans was only increased by $1,000 – from $56,000 in 2019 to $57,000 in 2020. This limit includes all employer and employee contributions to all defined contribution plans offered by that employer.
Highly Compensated Employees
There may also be additional limitations imposed on employee contributions if the employee is determined to be a Highly Compensated Employee (“HCE”). An HCE is, according to the Internal Revenue Service, anyone who has done one of the following:
Owned more than 5% of the interest in a business at any time during the year or the preceding year, regardless of how much compensation that person earned or received
Received compensation from the business of more than $125,000 if the preceding year is 2019; and $130,000 if the preceding year was 2020, and, if the employer so chooses, was in the top 20% of employees when ranked by compensation
There are special considerations for Qualified Plans as it relates to HCE. Specifically, if the average contributions of HCEs to the plan are more than 2% higher than the average contributions of non-HCEs, the plan would fail the ERISA non-discrimination test.
IRC § 415(d) requires that the Secretary of the Treasury annually adjust these limits for cost of living increases. However, these cost of living adjustments are not geared towards Key Employees and executive compensation.
Contribution Limits Impact Your Retirement
IRS qualified plan contribution limits are not in line with what key employees need to save for retirement. As such, these “Qualified” deferred compensation plans often provide limited utility for Key Employees. For example, imagine a key executive employee earning $750,000 per year. This hypothetical key executive can only defer $19,500 per year under their company’s 401(k) plan. This amounts to approximately 2.5% of the key executive’s yearly salary and does not consider HCE issues. Consequently, it is challenging for Key Employees to save enough through qualified plans to live a comparable lifestyle in retirement.
For that reason, employers often turn to nonqualified deferred compensation plans to make up this savings shortfall. These plans can also provide key executive employees with an additional tax-deferred growth opportunity. This could theoretically allow the executive employee to fund their retirement in a way that is consistent with their current standards of living.
Chasen Cohan, Esq. is the founder of Cohan PLLC. Mr. Cohan is a licensed attorney who also possesses FINRA Series 7 (Registered Representative) and Series 63 (Uniform State Representative) licenses, state insurance licenses, and State Securities Registrations in Nevada, Missouri, and North Carolina. Mr. Cohan is admitted to practice law before the Nevada Bar, all Nevada State and Federal Courts, and the United States Court of Appeals for the Ninth Circuit.
Mr. Cohan’s representative clients have included: Wal-Mart Stores, Inc., Sam’s West, Inc., MGM Grand Resorts International, New York-New York Hotel & Casino, Mandalay Corp., The Treasure Island Hotel and Casino, The Cosmopolitan of Las Vegas, The Mirage Casino-Hotel, South Point Hotel & Casino, American Express, Barclays, US Bank, Wells Fargo, Citibank, and various life insurance companies and service providers.
Mr. Cohan is a Las Vegas native who graduated with honors from UCLA with a Bachelor of Arts degree in Political Science. Mr. Cohan received his Juris Doctorate from the University of Texas School of Law. During law school, Mr. Cohan served as a clerk for the Office of the Texas Attorney General and a Judicial Extern for United States District Court Judge James R. Nowlin.
Clients from global brands and middle-market companies to innovative startups and individuals trust Cohan PLLC to resolve their trickiest legal disputes. Whether that’s litigation in state or federal trial and appellate courts in Nevada; investigations and enforcement actions before government agencies; or mediation, arbitration, and regulatory agency proceedings. Cohan PLLC has litigated hundreds of millions in dollars of claims on behalf of corporate litigants. As a result of this experience, Cohan PLLC has been afforded the opportunity to selectively act as Plaintiff’s counsel on complex, personal injury matters.