Personal Finance: IRS announces new retirement savings limits

Chris Hopkins of Barnett & Co.
Chris Hopkins of Barnett & Co.

Each year, the Internal Revenue Service determines the maximum contribution allowed for 401(k) retirement plans based upon changes in the price level. Last week, IRS announced the new limits for 2016, and the answer is drum roll no change. That's because the inflation rate for the previous year was within a rounding error of zero.

Unfortunately, for too many workers anticipating eventual retirement, their contributions are nowhere near the statutory maximum allowed. Myriad surveys and studies have documented the systemic undersaving of employees without access to a traditional pension plan. With each passing year, the difference between plan participation and the amount required to retire comfortably grows wider. Perhaps now is a good time to review your own savings plan and take action to correct deficiencies while time is still on your side.

Traditional pensions once predominated, but ultimately became too expensive to maintain as life expectancies expanded and a number of large employer plans collapsed with the demise of the sponsoring companies. Responsibility for banking up a war chest for retirement has since devolved upon the worker, with some employer participation optionally offered as a benefit or inducement.

The result has been the so-called defined contribution plan, into which an employee or self-employed individual systematically saves up or defers current income to invest and then draw upon once the paycheck stops. The most common such plan is the 401(k), after the section in the tax code defining such plans. Other analogous iterations include 403(b) and 457 plans.

Deferred compensation arrangements have existed for decades, known as cash or deferred arrangements (CODAs). Disputes over the tax deferral characteristics of these arrangements ultimately led to the codification of tax-deferred profit sharing plans in 1978. Johnson and Johnson became the first major corporation to adopt a 401(k) plan in 1979. By 1981, the code was amended to allow voluntary salary deferrals, creating the framework of the plans familiar to us today.

Limits on contributions were typically raised only episodically in response to bouts of inflation, and were often woefully inadequate. In 2001, major tax reform legislation indexed the contribution limits to inflation as measured by the CPI, and also established "catch up" provisions allowing workers age 50 or older to exceed the limits by a defined amount also indexed for inflation.

According to the IRS announcement, the maximum allowable salary deferral by an employee into a defined contribution plan for 2016 remains at $18,000. Employers will be allowed to contribute to the worker's account up to a maximum total of $53,000 from all sources. And if you are age 50 or over, you will be allowed to top off with an additional $6,000, just like last year.

Obviously, it is better to save more, and the tax benefits of these qualified plans provide an extra boost by postponing taxes on your earned income until you retire. Still, clearly not everyone is able to defer the maximum amount given their current financial position. But too many of us leave free money on the table by not deferring at least enough to get the full employer match (if offered). A study by Financial Engines estimates the average worker missed out on $1,336 last year in matching contributions, and will waive an estimated $42,000 over a 20 year work life.

Even if you are not able to make the full leap, resolve to move toward maximum employer matching as a goal and take one small step this year. And if you are able to max out your own deferral, by all means do so.

Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co.

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