Pension Bill Could Lift "Hidden" Ceiling on Contributions

February 14, 2001 ( - While much attention has focused on the change in deferral amounts under the Portman-Cardin pension reform proposal, a less publicized provision may have an even greater impact on how much workers save, according to the Profit Sharing/401k Council.

Under current law, employers only receive a tax deduction for plan contributions up to 15% of total compensation paid to all participants during the taxable year, up to $170,000 per employee at present (“covered comp”).  This 15% limit is imposed on both the pre-tax deferrals by the employee and the matching and/or profit-sharing contributions by the employer, according to Ed Ferrigno, Vice President, Washington affairs, for the PSCA.

As a consequence, many employers have limited employee 401(k) contributions to 15% of pay, regardless of other regulatory restrictions.  In fact, PSCA notes that over 50% of 401(k) plans currently impose a 15% limit on those contributions.

The Portman-Cardin proposal would provide relief in two ways, according to Ferrigno.  First, it would exclude employee pre-tax deferrals from the 15% limit, and it would increase that tax deduction to 25% of covered compensation.

Employees Unaware

Employees are often unaware that these limits are imposed by law, rather than the employer.  For example, if an employer is making a 3% match (i.e., 50% of the employee’s first 6%), the employee’s deferral would be limited to 12% of pay.

These limits are frequently imposed before a plan even gets to the average deferral percentage test, or the $10,500 deferral limit.

However, many employers have imbedded the 15% limit in their plans as a plan limit, rather than simply referencing the deductible limit under Section 404.  Plan sponsors would be well-served to dust off their plan documents and make sure that their plan is ready to take advantage of an increase in the limit if it comes.  If not, it may be time to amend your plan document.

Money Purchase Past?

Another possible impact of these changes might be the elimination of a large number of money purchase plans, according to Paul Lang, an attorney with Dow, Lohnes & Albertson.  Smaller plan sponsors looking to avoid running afoul of the current 15% deductibility limit frequently adopt money purchase plans, in addition to profit-sharing programs.  Money purchase plans are defined benefit plans, and subject to different limits.  Lang notes that if the deductibility limit is increased, employers will likely opt for the simplicity of a single plan to provide benefits, rather than splitting contributions between the two.

All in all, the combination of higher deductibles and contribution limits could well lead to less administrative complexity and, yes higher contributions by those in the non-highly compensated groups.

However, despite a broad range of bipartisan support, industry groups are increasingly concerned that if the bill is considered separately from the Bush tax proposal, it may not be passed in 2001.