401(k) Contribution Limit Rises to $19,500 in 2020
Catch-up contribution for plan participants age 50 or older rises to $6,500
Update: The IRS issued 2021 retirement plan limits on Oct. 26, 2020; see the SHRM Online article For 2021, 401(k) Contribution Limit Unchanged for Employees, Up for Employers. |
Employee 401(k) contributions for 2020 can increase by $500 to $19,500, while the combined employer and employee contribution limit rises by $1,000 to $57,000, the IRS announced on Nov. 6, 2019.
For participants ages 50 and over, the additional "catch-up" contribution limit will rise to $6,500, up by $500.
HR and payroll managers should adjust their systems for the new year and inform employees about the new limits in year-end open enrollment materials. Because the IRS announced the 2020 contribution changes so late this year, many plan sponsors will need to provide addendums to benefits materials that have already been printed for the 2020 benefits open enrollment period.
2020 Defined Contribution Plan Limits
In Notice 2019-59, the IRS highlighted the following adjustments taking effect on Jan. 1, 2020, for 401(k), 403(b) and most 457 plans:
"Employees over age 50 who are racing to retirement will be pleased to know they can contribute an additional $500 over the previous catch up contribution limit of $6,000, which hasn't been increased since 2015," said Danielle Capilla, director of employee benefits compliance at Alera Group, a network of insurance and financial services firms.
Otherwise, however, the 2020 announcement contains few surprises, with "everything going up roughly in lockstep, indexed for inflation," said John Lowell, an Atlanta-based partner and actuary with October Three, a retirement plan advisory firm.
Annual contribution limits for defined contribution retirement plans are adjusted each year to include the effects of inflation in $500 increments for employee contributions and $1,000 increments for the overall limit on plan contributions from all sources, explained Harry Sit, CEBS, who edits The Finance Buff blog. If inflation—as measured by the consumer price index for urban wage earners and clerical workers, or CPI-W—is not sufficient to trigger these increments, the limit will stay unchanged for the new year.
[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]
Complying with Contribution Limits
IRS records show that the vast majority of employees comply with annual limits on the amount of compensation that they can contribute to their 401(k) plans, according to a 2018 report by the Treasury Inspector General for Tax Administration. Nonetheless, the inspector general identified two areas in which compliance could be improved:
- Some 401(k) plans did not prevent taxpayers from exceeding the annual limit.
- Some employees exceed annual limits when contributing to multiple 401(k) plans.
The findings suggest that employers ensure that their payroll systems don't accept participant contributions that exceed the annual dollar limit, and that employers educate plan participants who may be holding more than one job that the annual limit applies to total contributions to all 401(k) plans.
"Over-contribution means having to deal with a long series of headaches to make up for the mistake," noted Evan Ross, content marketing manager at ForUsAll, a provider of 401(k) plan services for small companies. "This usually results in unhappiness all around. Employees face a potentially significant financial inconvenience, and as plan administrator, it's mostly your problem to deal with."
He advised:
- Warning employees with multiple plans that they can be more vulnerable to accidental over-contribution.
- Adding validation checks to payroll systems, to prevent over-contributions from happening so that "you don't have to spend your valuable time on fixing mistakes months down the line."
Annual Limit as a Contribution Goal
HR professionals should convey to employees their plan contribution limits for next year. Not all plan participants will be able to fund their 401(k) accounts up to the maximum, of course, but the contribution cap is a goal they should keep in mind and may encourage those who can defer extra dollars for retirement savings to do so.
According to Fidelity Investments, employees' average 401(k) contribution rate is now 8.8 percent of their pay, nearly a full percentage point higher than 10 years ago.
With the annual increase in the employee contribution limit, a good message for plan participants is that "increasing your contribution rate, even by 1 percent, can make a big difference in your long-term retirement savings," said Kevin Barry, president of workplace investing at Fidelity. "What may seem like a small amount today can have a significant impact on your account balance in 10 or 20 years."
Those who have not been contributing enough per paycheck to reach the annual cap and who can afford to do so can increase their contributions before the end of the year so that they reach the full annual limit.
Conversely, participants may want to ensure that they don't hit the annual limit prior to year-end, which could mean losing out on employer matching contributions tied to per-paycheck deferrals, unless the plan sponsor has agreed to "make whole" or "true up" participants who max out their annual contributions prior to their final paycheck.
401(k) After-Tax Contributions A Roth 401(k) is funded with after-tax dollars and withdrawals are tax-free during retirement, while a traditional 401(k) is funded with pretax dollars and withdrawals are taxed as income during retirement. Many plans allow participants to convert dollars in a traditional 401(k) account to the plan's Roth account, although the participant must then pay income taxes on all dollars (pretax contributions and earnings) being converted. When withdrawn from the Roth account during retirement, no taxes are subsequently owed. Some plans, however, will also allow employees to make additional after-tax—but non-Roth—contributions to a traditional 401(k) once the 2020 participant contribution limit of $19,500 (or $26,000 after age 50) is exceeded, up to the "all sources" contribution limit of $57,000 (or $63,500 after age 50). If the plan document allows after-tax contributions to a traditional 401(k), then by following the correct steps employees can convert these contributions to Roth dollars within the plan, or to a Roth individual retirement account (IRA), so that the after-tax traditional 401(k) contributions become, effectively, Roth contributions. At the time of the conversion, only earnings are taxed as income, while the dollar amount of the after-tax plan contributions will covert tax free. |
Defined Benefit Plan Limits
Sponsors of defined benefit pension plans should note that the IRS announced the following cost-of-living adjustments under tax code Section 415, also taking effect on Jan. 1:
- Annual benefit limit. The maximum annual benefit that may be provided through a defined benefit plan rises to $230,000 from $225,000.
- Separation from service. For a participant who separates from service before Jan. 1, 2020, the annual benefit limit for defined benefit plans is computed by multiplying the participant's compensation limit, as adjusted through 2019, by 1.0176. This is an increase from the previous year, when the participant's compensation limit, as adjusted through 2018, was multiplied by 1.0264.
Separately, the federal Pension Benefit Guaranty Corp., which insures private-sector defined benefit pension plans, posted 2020 premium rates for single-employer and multiemployer pension plans.
SIMPLES, SEPs and ESOPs
IRS Notice 2019-59 also provides adjusted limits and thresholds for other workplace retirement plans:
- For SIMPLE (savings incentive match plan for employees of small employers) retirement accounts, the maximum contribution limit increased to $13,500 from $13,000. The SIMPLE plan catch-up contribution limit remains $3,000.
- For simplified employee pensions (SEPs), the minimum compensation threshold remains unchanged at $600. The SEP maximum compensation limit rises to $285,000 from $280,000.
Defined Contribution Plans: Similar and Different 401(k) plans offered by private employers and 403(b) plans, designed for tax-exempt and nonprofit organizations such as schools, hospitals and religious groups, meet specifications laid out in Section 401(a) of the U.S. tax code and are therefore known as tax-qualified plans. Both plan types share the same tax advantages, contribution limits, Roth options and early withdrawal penalties, although some of the rules regarding plan administration and compliance with the Employee Retirement Income Security Act (ERISA) differ. But 457 plans, offered by state and local public employers and some nonprofit employers, are considered nonqualified retirement plans and are not governed by ERISA. In addition, 457 plans differ from 401(k) and 403(b) plans with regard to catch-up contributions, early withdrawals and hardship distributions. If an employee has both a 401(k) and 403(b) retirement plan, whether from the same or different employers, their combined contributions to both plans together are capped at $19,500 next year plus the $6,500 catch-up contribution for participants who are age 50 or older, while employer-plus-employee contributions top off at $57,000 for both plans combined. However, the IRS allows participants who contribute to a 401(k) and a 457 plan at the same time to contribute the maximum amount to both plans separately, and the same holds for employer-plus-employee limits. Likewise, participants with a 403(b) plan and a 457 plan can contribute to each separately up to each plan's annual limit. |
IRAs
The limit on annual contributions to an IRA remains unchanged at $6,000. The additional catch-up contribution limit to an IRA for individuals age 50 and over remains $1,000.
Although personal IRAs are not employer plans, the amount that account holders can contribute annually is affected by whether they have a workplace retirement plan and how much they earn.
The income ranges for determining eligibility to make deductible contributions to traditional IRAs, and eligibility to contribute to Roth IRAs, increased for 2020 as shown below.
Traditional IRA Deduction Phase Out:
Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. If during the year either they or their spouse was covered by a retirement plan at work, the deduction may be phased out until it is eliminated, depending on filing status and adjusted gross income (AGI):
- For single people covered by a workplace retirement plan, the IRA phase-out range is $65,000 to $75,000, up from $64,000 to $74,000.
- For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $104,000 to $124,000, up from $103,000 to $123,000.
- For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple's income is between $196,000 and $206,000, up from $193,000 and $203,000.
- For married individuals filing a separate return who are covered by a workplace retirement plan, if they lived with their spouse at any time during the year, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
Roth IRA Income Phase Out:
The 2020 AGI phase-out range for taxpayers contributing to a Roth IRA are:
- For singles and heads of household, the income phase-out range is $124,000 to $139,000, up from $122,000 to $137,000.
- For married couples filing jointly, the income phase-out range is $196,000 to $206,000, up from $193,000 to $203,000.
- For married individuals filing a separate return, if they lived with their spouse at any time during the year, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
Related SHRM Articles:
Consider True-Up Payments for Employer Matching Contributions, SHRM Online, October 2019
DOL Proposal Will Shift 401(k) Participant Disclosures Online, SHRM Online, October 2019.
IRS Final Rule Eases 401(k) Hardship Withdrawals, Requires Amending Plans, SHRM Online, September 2019
Other 2020 Inflation-Adjusted Limits/Thresholds:
2020 Benefit Plan Limits and Thresholds Chart, SHRM Online, November 2019
2020 FSA Contribution Cap Rises to $2,750, SHRM Online, November 2019
2020 Payroll Taxes Will Hit Higher Incomes, SHRM Online, October 2019
PBGC Raises Pension Premium Rates for 2020, SHRM Online, October 2019
2020 HSA Limits Rise Modestly, IRS Says, SHRM Online, May 2019
IRS Lowers Employer Health Plans' 2020 Affordability Threshold, SHRM Online, July 2019
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