It is possible the IRS’ qualified retirement plan contribution limits
Similarly, the total employer plus employee contributions to all defined contribution plans by the same employer will increase by $1,000 from $55,000 in 2018 to $56,000 in 2019. The age-50-or-over catch-up contribution is on top of this limit.
There may also be other limitations on employee contributions if the employee is determined to be a “Highly Compensated Employee” (“HCE”). The income threshold in 2019 increased $5,000 to $125,000. The HCE test is a bit more complicated than this simple threshold, but it is not relevant to this discussion.
Section 415 of the Internal Revenue Code also provides for dollar limitations on benefits and contributions under all qualified retirement plans. In 2019, the limitation on the annual benefit under a defined benefit plan under Section 415(b)(1)(A) increased from $220,000 to $225,000.
Section 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 retirement plan contribution limits might not be in line with what a key employee needs to save for retirement. As such, “qualified” deferred compensation plans can often provide limited utility for highly compensated executive employees. For example, imagine a key executive employee earning $750,000 per year. This hypothetical key executive can only defer $19,000 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, this is likely not enough for thish hypothetical key executive 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.