New Legislation Increases Maximum Plan Contributions
by Margery F. Paul
(County Bar Update, November 2001, Vol. 21, No. 10)

 

New Legislation Increases Maximum Plan Contributions

By Margery F. Paul, MSPA, MAAA, EA, written at the request of the Law Practice Management Section Executive Committee. Paul is a consulting actuary with the law firm of Reish Luftman McDaniels & Reicher in West Los Angeles. She can be reached at margepaul@reish.com. The opinions expressed are her own.

Recent legislation has substantially increased possible retirement plan contributions. Beginning in 2002, the maximum salary deferral contribution to a 401(k) plan increases from $10,500 to $11,000, and the maximum total contribution for an employee increases to $40,000 or 100% of pay, whichever is less. (This number includes deferrals, employer matches and profit sharing.) In addition, employees who are age 50 or older will be able to make "catch-up" 401(k) contributions of $1,000 in 2002. Catch-up contributions are not subject to any plan limits or testing.

The larger contributions described above must also be deductible to the firm. The new law provides good news here, too. The maximum deductible contribution to a 401(k) plan increases to 25% of the total compensation of all of the eligible employees. In addition, employee deferrals no longer count against this limit.

The following table shows the contributions that can be made to a 401(k) plan by a small firm.

 

Maximum 401(k) Contributions for Employees 50 or Older

 

Considered
Compensation

Profit Sharing

401(k) Deferral Catch-Up Deferral Total
Current
Law:
$170,000 $15,000* $10,500 --- $25,500*
    New Law
(in 2002):
$200,000 $29,000 $11,000 $1,000 $41,000
* Limited by maximum deduction rules

Effective for years ending in 2002, the defined benefit plan limits will increase approximately 14% to 63%, depending on the participant’s age and assumed retirement date. The following is a table of possible contributions under new law:

   

Age at
Plan Inception 

Assumed Retirement Age New Law Contribution Lump Sum at Retirement
40 55 $60,100 $1,400,000
45 55 $106,100 $1,400,000
50 60 $136,100 $1,800,000
55 62 $165,300 $1,400,000
60 70 $179,800 $2,400,000

Note that these contributions maybe deducted in 2001 for a plan that is established on or before the end of 2001, provided the plan year ends in 2002.

Most employers sponsor 401(k) plans. However, due to the greatly increased benefits and contributions that are now available to partners, many law firms are setting up new defined benefit pension plans to operate in combination with their 401(k) plans.

One problem for a very small firm (i.e., 1 to 10 employees) is that the maximum deduction for combined defined benefit and 401(k) plans is 25% of the compensation for all of the eligible employees, or the defined benefit plan contribution if greater. This deduction problem disappears for larger firms.

The table below shows possible contributions for a combined 401(k) plan and defined benefit plan.

Maximum Possible Contributions in 2002 Assuming Retirement Age is 65

   Age Defined Benefit 401(k) Employer 401(k) Employee Total
  40 43,000 + 29,000 + 11,000 = 83,000
  45 58,000 + 29,000 + 11,000 = 98,000
  50 80,000 + 29,000 + 12,000 = 121,000
  55 140,000 + 29,000 + 12,000 = 181,000
  60 164,000 + 29,000 + 12,000 = 205,000
  65 210,000 + 29,000 + 12,000 = 251,000

For law firms, plan design will be key to determining whether they can benefit from implementing a defined benefit plan, since it will be important to keep employee costs at a reasonable level. This can be accomplished by experienced consultants using sophisticated techniques.

Those firms that do not currently sponsor a defined benefit plan but that are interested in significantly increasing benefits for partners should move quickly to evaluate adding a defined benefit plan or cash balance pension plan before the end of the year.

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