IMHO (In My Humble Opinion): The Limits of Limits

One of the most visible - and eagerly anticipated - components of the proposed pension reform legislation is the increase in the 401(k) deferral amount from $10,500/year to $15,000.

Enthusiasm for this idea seems to be fairly widespread. It has been widely touted by any number of industry groups. Support has also shown up in a variety of individual investor surveys, including our own weekly readership survey that found it to be the most popular component of the proposal.

» Do The Math
» The Real Problem
» So What

And why?  Ostensibly because we all believe that saving more for retirement is a good thing, and because being able to save more for retirement is, at its simplest, more of a good thing.  But that of course assumes that the problem is a limitation on how much you can save, rather than a limit on how much you have AVAILABLE to save.


Do the Math

The reality is that most workers don’t even get close to saving $10,500 each year, and not because the government is blocking them.  A worker making $50,000 annually would have to be able to set aside 21% of his pre-tax salary just to get to the $10,500 contribution limit. Most “working families” have more pressing needs for that money.

So why the big push to raise the limit?  There is a very real sense that we need to encourage more employers to offer retirement plans – and some evidence that self-interest can be a powerful motivator.  Make it easier for small business owners to save more for their own account, and common logic says they will be more likely to offer 401(k) plans for their employees.

Makes sense, right?  Maybe a slight case of “the rich get richer,” but if more workers have more and better ways to save, why should we care?


The Real Problem

The reality is that, just as the $10,500 cap isn’t the real limiting factor for average workers, it’s frequently not the barrier for the highly paid group, either. Not that it doesn’t hit some, mind you, but the real problem for most is another limit, the average deferral percentage (ADP) nondiscrimination test.

That’s the standard that restricts the average percentage deferred by so-called highly compensated employees (generally those earning more than $80,000/year), based on a multiple of the deferrals of the rest of the eligible employees. While we have seen no statistics on the relative impact of the two limits, experience suggests that it is the application of the nondiscrimination test, not the deferral limit, that impacts more people.

Unfortunately, that situation isn’t immediately – or directly – being addressed by the pension reform proposals floating around.  When it comes to encouraging contributions, the focus is on the increase in the deferral limit.


So What

So, if we raise the deferral amount – and nothing else – what happens?  Well, if the nondiscrimination test is the real impediment, then higher compensated individuals will only be able to contribute more IF the non-highly compensated individuals pick up the pace.  But, if those other employees can’t afford to save $10,500 today, how will lifting that limit change the amount they (can’t) save?

So, the nonhighly-compensated workers won’t be able to save any more than they can today – and with no change in the nondiscrimination test, the bar won’t be lifted for the highly compensated workers.  And if the highly compensated can’t save more, that incentive to establish retirement plans won’t materialize.

Which means that we all seem quite anxious to have something changed  – that isn’t likely to change a thing.

There are better places to start?Eand no time like the present.

Nevin Adams, Executive Editor
February 12, 2001

What do YOU think?  Drop us a line at . We will post your reactions here. Please include your name and company or let us know when you want to remain anonymous. Thank you!



I agree that the 401(k) deferral limit is not what is keeping our non-highly compensated from saving more. I am far more anxious to see the elimination of elective deferrals from the limitations under 404(a)(3), as proposed previously.  My NHCEs complain that the Plan won’t allow them to reach the Government’s $10,500 limit, not understanding that many other limits impact what the Plan can allow. 

Kathy Cissna
February 12, 2001
I agree that many HCE’s will not benefit from the proposed increase, but in some of the Plans that I administer, the HCE is limited by the $10,500 because we have near 100% participation by the non-highly’s with average deferrals of 6% + (not to mention the safe harbor plans).  The proposed increase would allow only a few of my clients (plan sponsors) to increase their deferrals.  I am a great proponent for an increase if these few individuals are able to defer more of their salary for their retirement.  And, there may be a day where I am in their shoes, wishing I could save a few thousand more per year!

Janice Cackowski
February 12, 2001
I have said this all along to people who have asked my opinion concerning the increase in the annual dollar limit.  It just sounds good politically. The ADP test must be eliminated.  If the truth were told, it is simply a ruse by the IRS to limit lost taxable income and not about discrimination. Let’s at least be honest. 

Lest we also forget, there is a 15% tax deduction limit that companies must contend with on their own tax returns.  They get you coming and going.

David Deason
February 12, 2001
If one is not highly compensated, currently $85,000.00 during the prior plan year, the increase in the deferral amount can still be beneficial.  What about the group of worker’s who hold two jobs.  One job to live on, and another part-time job to accumulate retirement savings. Usually the earnings from the part-time jobs must be saved post tax, since few part-time jobs have retirement plans.  Or if they were frugal enough to save money outside of a retirement plan, and would like to defer the taxes on the earnings from that accumulation.  They could defer more of the earnings from work, and use dividends, interest, or capital gains from their accumulated savings to supplement their income.


Al Harrington
February 12, 2001
You have the math right and to get the benefit a sponsor must be willing to also go to one of the “safe harbor” funding methods.  In our community we are finding that for many professional organizations [accountants, attorneys, computer analysts, doctors, etc.] the “safe harbor” funding method is becoming the basic plan that a firm has to offer if they expect to recruit new professionals.  

February 12, 2001
All of your points are well taken and may be totally “on the money”.   One other thought, thought, which could be added.  Matching contributions are an added incentive that many plans, including ours, use to encourage wider participation by the non HCEs.   We may find that many companies, AFTER experiencing ADP probl