Pension Trends   Volume VII, No. 4, November 2006    

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In this issue...

Super K 2006
2007 Limits
PPA '06 Watch
          

Super K 2006

Using hyperbole in a headline can sometimes annoy the reader who, after reading, learns the headline was a come-on, but our use of the adjective "super" is not hyperbole. The Pension Protection Act of 2006 (PPA '06) significantly enhances the attractiveness of adding a 401(k) plan for the business owner looking for ways to maximize his or her tax deferred retirement savings. It can add as much as $33,200 in tax-deferred contributions on top of an already large defined benefit plan contribution.

Until now, the maximum deductible contribution that could be made to the combination of a defined contribution plan and a defined benefit (DB) plan was limited to the greater of 25% of eligible payroll or the minimum required contribution for the DB plan. So, adding a defined contribution plan on top of a high contribution DB plan, in general, did nothing to increase the maximum contribution.

It has been true for some time that 401(k) salary deferrals, including catch-up contributions, are not taken into account for purposes of the 25% of payroll limitation. For 2006, the maximum salary deferral is $15,000 and the maximum catch-up contribution available to an employee who is at least age 50 during the year is another $5,000. Thus, a 50-year-old business owner can make an additional $20,000 of salary deferral contributions on top of his or her DB contribution. However, if even $1 of non-elective or matching contribution is made to a 401(k) plan, the 25% of payroll contribution limitation under IRC § 404(a)(7) applied.

PPA '06 added a new layer of contribution that can be made to a 401(k) plan without invoking the 25% limitation. Effective in 2006, a non-elective contribution that does not exceed 6% of pay is also not taken into account. For a business owner whose compensation is $220,000 or more, that adds another $13,200 that may be contributed to the 401(k) plan.

For the small business owner with no employees, this Super K plan gives him or her the opportunity on a year-by-year basis, completely at his or her discretion, to contribute from $0 to $33,200 in addition to the DB plan contribution. For the small business owner who is not yet age 50, the amount is $28,200, and for business owners whose compensation is less than $220,000, the discretionary amount is also less. For example, for the small business owner age 50 whose compensation is $140,000, the additional contribution could be $28,400. But in all cases the opportunity is the equivalent of a "super-sized" 401(k) salary deferral.

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2007 Limits

Every year the IRS announces the new limits that apply to various aspects of qualified plans. For example, the maximum compensation that may be recognized for plan purposes in 2007 will increase from $220,000 to $225,000. These and all other limits announced by the IRS can be found on our retirement plan limits page.

When doing financial and tax planning with your clients, it is important to keep these changing limits in mind. The amount of tax deductible contribution that can be made to both defined benefit and defined contribution plans continues to go up.

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PPA '06 Watch

We at IAI are studying all the provisions of PPA '06 to evaluate the potential impact on our clients. We are paying particular attention to those provisions that take effect in 2006 and 2007. (Many of the major funding changes don't take effect until 2008.) Our clients can rest assured that we will be proactive in managing your retirement plans to comply with and take advantage of the changes created by PPA '06.

If you have concerns or questions, please feel free to give us a call. If you would like more information, we can provide it to you. You might also want to visit our overview analysis and links to other sources of analysis of PPA '06.

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This newsletter has been published in order to share general information with our professional contacts. The information presented in this newsletter should not be acted upon without first seeking the advice of a CPA, attorney or other benefit professional.