Dec 13, 2021
As a plan sponsor, you know that administering a retirement plan in compliance with the tax laws can be challenging, in part because there are so many rules that govern retirement plan operations.
Some of these rules are tied to the contribution and compensation dollar limits that can change each year in relation to cost-of-living adjustments. Although an increase in the limits means that you and your employees can save more for retirement, your plan might be affected in other ways.
It’s important to be aware of these limits and how they interact, so you understand when additional employer contributions may be required,
for example, or a plan design change may help your plan pass nondiscrimination tests.
Here are the plan contribution and other dollar limits for 2022, followed by a reminder of how each of these limits affects retirement plan operations.
401(k) & 403(b) Elective Deferrals
A plan participant may defer up to $20,500 from their salary into a defined contribution retirement plan in 2022, not including catch-up contributions. This limit is often referred to as the “402(g)” limit in reference to the section of the Internal Revenue Code in which it is found. It applies for both pre-tax and Roth contributions in aggregate, and it applies to all 401(k), 403(b), and SIMPLE IRA plans an individual participates in for the year. Employees who participate in a governmental 457(b) plan have a separate deferral limit of $20,500 for that plan.
If a plan allows for catch-up contributions, participants aged 50 and older may contribute an additional $6,500 for 2022 over the elective deferral limit. Highly compensated employees whose deferrals are limited by the ADP test may treat deferrals in excess of the ADP limit as catch-up contributions, which are excluded from the ADP test. 403(b) plans and governmental 457(b) plans may have additional special catch-up provisions.
Defined Contribution Plan Limit
This limit is referred to as the “Annual Additions” limit or the “415 limit” (in reference to the applicable Internal Revenue Code section). It controls the amount an employee may receive in their plan account for the year under plans maintained by the same employer. If the employee participates in more than one plan maintained by unrelated employers in the same year, the employee will have two Annual Additions limits. Employee and employer contributions (including forfeitures) allocated to a plan participant’s account for 2022 must be limited to the lesser of:
- 100% of the participant’s compensation, or
Catch-up contributions are not included in this limit. If a participant age 50 or older makes a full catch-up contribution in 2022, their total contributions could be as much as $67,500.
Annual Compensation Limit
This limit is referred to as the “Compensation Cap.” Only a certain amount of a plan participant’s compensation may be used to calculate contributions. For 2022, that limit is $305,000. So, for example, if a participant earns $400,000 in compensation, the employer can use no more than $305,000 to calculate the participant’s share of a profit-sharing contribution. As this limit increases, higher paid employees can receive higher plan contributions.
Highly Compensated Employee Threshold
A highly compensated employee (HCE) is an employee who:
- Owns more than 5% of the employer at any time during the year or preceding year, or
- Earned more than $135,000 for 2022 from the employer and, if the employer elects, had compensation that ranked the employee in the top 20% of all employees.
Employees are placed either into an HCE group or a non-HCE group for the 401(k) plan nondiscrimination tests: the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test. The ADP test limits the percentage of compensation the HCE group can defer into the 401(k) plan, based on the deferral rate of the non-HCE group. The ACP test ensures that the employer matching contributions and after-tax employee contributions contributed for HCEs are not disproportionately higher than those for non-HCEs. An increase in the compensation level to be categorized as an HCE may result in fewer employees being categorized as HCEs, which may improve a plan’s ADP/ACP test results.
Key Employee Threshold
A key employee is an employee who
- Owns more than 5% of the employer
- Owns more than 1% of the employer and has annual compensation of more than $150,000, or
- Is an officer of the employer and has compensation of more than $200,000 for 2022
Key employee status is used to determine how employees are categorized for the top-heavy test, which measures whether plan assets are concentrated in the accounts of business owners or officers earning a certain amount of compensation. A plan is top-heavy if more than 60% of its assets are held in the accounts of key employees. The determination is made as of the last day of the preceding plan year (December 31 for a calendar-year plan). If the plan is deemed to be top-heavy as of December 31, 2021, the employer may be required to make up to a 3% contribution for its non-key employees. An increase in the compensation amount to qualify as a key employee may result in fewer employees being included in the key group, which may improve the top-heavy test results.
Taxable Wage Base
The taxable wage base is set by the Social Security Administration, rather than the IRS, because it controls the maximum amount of an employee’s compensation that is subject to Social Security and Medicare taxes. For 2022, up to $147,000 of compensation will be subject to these taxes. This limit may also apply when plan sponsors use the Social Security integration method for allocating employer contributions, also known as the permitted disparity contribution formula.
After you review the increases in the limits, you may want to:
- Review the 2022 limits with your internal payroll staff or payroll service provider to make sure any necessary adjustments are made to incorporate the increased limits.
- Confirm that the correct definition of compensation from your plan document is being used to determine compensation for plan contributions.
- Identify your HCEs and key employees for 2021 and determine whether the increase in compensation thresholds will reduce the number of employees in these groups. If it does, your plan might be more likely to pass the nondiscrimination tests in 2022.
- If your plan fails any of your 2021 contribution limit or nondiscrimination tests, discuss with your Newport representative the correction options for your plan (e.g., distributing excesses to HCEs or making additional contributions to non-HCEs). If you anticipate potential testing failures in 2022, you may want to explore with your Newport representative plan design changes that may help your plan pass testing in future years (e.g., automatic enrollment, safe harbor 401(k) plan design).
Newport Group, Inc. and its affiliates provide recordkeeping, plan administration, trust and custody, consulting, fiduciary consulting, insurance and brokerage services. Newport strives to provide information that is accurate as of the date of publication. However, we cannot guarantee that the information contained herein is accurate as of the date it is received or that it will continue to be accurate in the future. This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before making any decisions. Newport and its affiliates do not provide tax, legal or accounting advice.