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Understanding 401K Catch Up Contributions

401K-Catch-Up

Retirement

Understanding 401K Catch Up Contributions

The U.S. Congress has made an addition to retirement plans by including new catch-up contributions. This is due to the concern that most baby boomers haven’t saved enough funds for their retirement. The new option allows employees age 50 and above to increase their contribution when their retirement age draws near. Age-50 401K catch up contributions are applicable for 401k, 457 plans, 403(b) as well as IRAs; however, the rules are different among plans. This article will focus on 401k rules.

The term 401K catch up contribution refers to an elective deferral made by an employee of age 50 or above. This contribution should exceed a plan-imposed limit, statutory limit, or in case of highly compensated employees, actual deferral percentage limit.

An employee can make catch-up contributions to a 401k account, a governmental 457(b) plan, a 403(b) plan, or a SIMPLE-401k.

For 2017, the limit on catch-up contributions to a 401k account is $6,000.

As per American Plan Sponsor Council, over 97% of 401k plans allow catch-up contributions.

Usually your plan will have to be amended if you want to offer catch-up contributions. The probability is very high for most 401k retirement plans. The IRS has given assistance in this regard by providing a model amendment language which may be used by most employers, but it is better to check immediately with your record-keeper and legal counsel on exactly what your plan requires. This will assist you in making an informed decision.

401K Catch Up Contributions: Age 50 and Above Rule

Employees who satisfy the eligibility criteria to make 401K catch up contributions are called catch-up eligible participants.  An employee is eligible for catch-up contributions with regards to a certain plan if he or she turns 50 on the conclusion of the year in which the plan’s year comes to an end. The employee can make his or her elective deferral under the terms of the plan.

An employee is considered to be 50 years old any time during the course of the specific calendar year in which they turn 50. Therefore, in the case of a non-calendar year plan, an employee is allowed to make catch-up contributions even in case he or she does not turn 50 years till the subsequent plan year, only if he or she will turn 50 by the conclusion of the calendar year in which he makes catch-up contributions.

For example, Alan will turn 50 on 30 November, 2017 and he opts for a plan which allows him to make 401K catch up contributions. His plan’s year is from 1 October to 30 September. Alan will be of age 50 on 1 January, 2017. He is qualified to make catch-up contributions to his plan for the plan’s year that ends on 30 September, 2017, even if he doesn’t turn 50 till the next year.

Exceeding Contribution Limits

Catch-up contributions are, usually, elective deferrals from eligible participants. These contributions exceed a limit set by the statute, a plan-imposed limit, or an ADP limit.

Statutory limits are legal limitations on the contribution amount a person can make to a certain plan. In terms of a 401k plan, the applicable statutory limit is in IRC Section 401 (which limits the dollar amount of elective deferrals to $18,000 for 2017) and IRC Section 415 (which limits the yearly addition to an employee’s account in a specific contribution plan to the lower of $54,000 or 100% of the employee’s compensation, for 2017).

In contrast, plan-imposed limitations are limits on the contribution amount that are specified in the relevant documents of the plan. For instance, a stipulation that restricts the amount of elective deferral to ten percent of the participant’s remuneration is an imposition of the plan. The ADP limitation is the limit for high compensation employees and the ADP test for a plan year determines it.

For example, Judith participates in a 401k plan which allows her to make catch-up contributions. She is 55 years old and is, therefore, a catch-up eligible employee. For plan year 2017, she defers $24,000 to her plan. According to IRC Section 401 the 2017 limit is $18,000. The limit with respect to her catch-up contribution for 2017 is $6,000 and the plan considers $6,000 of her deferral amount as catch-up contribution.

Income Makes a Difference

In case you earn less than $100,000 in income, maxing out your 401k account and making 401K catch up contributions usually means saving over 20% of your earnings, which seems like a difficult job.

And, according to Fidelity, on a national level, employees who manage to max out their regular limit are a modest 9%. Employees who tend to max out their regular contributions but do not go for catch-ups are about 10% of total workers.

Employees usually hop on the 401K catch up contributions bandwagon after they Google various retirement topics. They carry out a search for maximum limits on a yearly basis and set their financial goals accordingly. A number of companies take their own outreach initiatives; they message employees as they approach the age of 50. You can start making the catch-up contributions in the year you turn 50.

Audit Tips

These audit tips, related to 401K catch up contributions, will help you in ensuring compliance with legal and regulatory compliance requirements. Here are some of them:

  • The first thing is to figure out if your specific plan allows catch-up contributions
  • Then find out if your plan has a plan-imposed limitation with respect to elective deferrals
  • Review the contributions to your plan to figure out if there have been any breaches of the restrictions in IRC sections 401, 415, or any provisions of the plan
  • Also carry out a review of the ADP criteria to figure out the limits for HCEs
  • In case of breach of relevant limits, consider if the employees who were responsible for making additional elective deferral amounts are of age 50 or above by the conclusion of the relevant calendar year
  • Review your payroll and salary records to ensure compliance with the catch-up contribution limit ($6,000 for the year 2017).

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