November 17, 2005

IRS Announces 2006 Pension Plan Contribution Limits

The Internal Revenue Service recently announced 2006 tax year cost-of-living adjustments to dollar limitations for pension plans and other items. Annual limits rise when applying the inflation index would result in a change of at least the specified minimum amount (e.g., $1,000 for the Section 415 dollar limit on contributions to defined contribution plans). Because inflation has been rising in recent months, the increases are larger than they have been in a number of years. In addition, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), mandated automatic increases in some limits (such as the 402(g) limit on salary reduction contributions to 403(b) and 401(k) plans) even if an inflation adjustment is not required.

• The Section 402(g) limit on the amount of salary reduction contributions to 403(b) and 401(k) plans increases from $14,000 to $15,000. The limit on deferrals to eligible 457(b) plans also increases from $14,000 to $15,000.
• The Section 415 annual dollar limit on combined employer and employee contributions to defined contribution retirement plans increases from $42,000 to $44,000.
• For defined benefit plans, the IRC Section 415 maximum annual benefit increases from $170,000 to $175,000.
• The maximum amount of an individual's annual compensation that can be taken into account under IRC Section 401(a)(17) for purposes of nondiscrimination testing and calculations of retirement plan contributions rises from $210,000 to $220,000. However, there are certain exceptions to this limit:
  • For governmental plans, the $220,000 limit generally applies only for purposes of calculating contributions for employees who became plan participants after the 1995 plan year. Employees who became participants in 1995 or earlier are generally subject to any limit that was in effect under their plans on July 1, 1993 (which could be no limit or the 401(a)(17) in effect at the time). For government plans that were subject to the 401(a)(17) limit in 1993, the 2006 limit for pre-1996 participants is $325,000.
  • For church plans exempt from nondiscrimination requirements, includible compensation limits do not apply.
• The additional amount (catch-up contribution) that employees aged 50 or older can contribute to a 403(b), governmental 457(b) or 401(k) plan in 2006 increases from the 2005 limit of $4,000 to $5,000.

The compensation floor for determining highly compensated employee (HC) status will rise from $95,000 to $100,000 in 2006. Employees with compensation over $100,000 in 2006 will be classified as highly compensated in plan years beginning in 2007. Alternatively, employers can elect to treat only their top-paid 20% as highly-compensated in 2007, if more than 20% receive compensation over $100,000 in 2006. Employees with compensation over $95,000 in 2005 will be classified as highly compensated in plan years beginning in 2006.

For qualified plans subject to the top-heavy rules, the floor for determining key employees will rise to $140,000 in 2006.

BENEFITS FUNDAMENTALS