Michael A. Webb, Vice President, Retirement Services, Cammack LaRhette Consulting, answers:
Thanks for the timely question. First of all, you’ll be pleased to hear that the elective deferral and most other limits increased last week (see IRS Announces Pension Plan Limitations for 2012). And, secondly, the methodology for increasing the limits is much less random than throwing darts at a dartboard!
Most retirement plan limits are indexed to inflation; the inflation rate is measured from the third calendar quarter of the prior year to the third quarter of the current year in determining the inflation factor to apply to the limit for the following calendar year.
The index utilized is a commonly known measure called the Consumer Price Index for All Urban Consumers, or CPI-U. For many limits, it is not enough for the change in CPI-U to be positive for the limit to increase. The index must be so positive that the limit would increase by more than a certain incremental dollar amount. For example, the 402(g) elective deferral limit, which was $16,500 in 2011, is indexed in increments of $500. After actually decreasing in 2009 (3rd quarter 2008 – 3rd quarter 2009), the index did increase in 2010, but only enough to bring the 402(g) limit to $16,629.
Since the next increment of $500 would have been $17,000, the index did not increase enough for the actual 402(g) limit to increase for 2011. However, the index for 2011 did sufficiently increase to bring that $16,629 limit past the $17,000 mark, thus resulting in our new 402(g) limit of $17,000 in 2012.
Since we’ve had a deflationary or flat inflation environment for the past few years, increases in retirement plan limits have been hard to come by. The next year will reverse that trend, but only time will tell what the future holds for limit increases. One thing that you can count on is the announcement of the limits for the following year, which generally takes place in mid-to-late October, as it did this year.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.