IRS Announces "Pretend Salary" Maximum for 2015

Each year around Halloween time, the IRS announces what I call the "Pretend Salary" maximum". For 2015 the amount is $265,000. Government regulators must be so jealous of those in private enterprises that have figured out how to make a pot full of money each year, that they have decided to pretend that nobody makes more than $265,000 per year. That way, the person who actually makes $530,000 will be treated as if they make half that amount for all retirement plan purposes.

"So what?", you may ask! (You did ask that, right?) Well, when you take their desired salary deferrals of $24,000 divided by their Pretend Salary maximum of $265,000, the Deferral Percentage is a fictitious 9.06% instead of the actual much lower salary deferral of 4.53% ($24,000 / $530,000). The name of that game is that you cannot do that much (the fictitious 9.06%) unless the Plan Sponsor is providing a Safe Harbor Plan or the rank-in-file employees are saving a ton, which isn't likely. Once again, the problem is the infamous ADP test (average actual deferral percentages of the Non-HCEs as compared with the average actual deferral percentages of the HCEs - normally, a 2% spread is all that is allowed). The Pretend Salary maximum also comes into play, if the business owner wants to max out for the year (2015) at the $59,000 overall limit.

Let's do a little Common Core Math word problem, shall we?

Suppose a business owner has a corporate salary of $700,000 and wants to get a Profit Sharing allocation of $35,000 added to his or her retirement plan account, then what percentage of Profit Sharing must be made by his or her company for the the staff? [Note that the salary deferral limit of $24,000 (over age 50) plus the $35,000 of Profit Sharing would get the business owner to the total limit of $59,000]. Your very bright 6th grader studying California Common Core Math would say to you "Well, that's easy! On a salary of $700,000, the $35,000 of Profit Sharing would represent a 5% of salary contribution for the owner. I got that using the "Ladder Method" instead of the "Standard Algorithm Method". So the Profit Sharing percentage for everyone would have to be 5% of their pay, right? I mean that seems fair, right?"

Not wanting to admit that you have no idea what the "Ladder Method" or the "Standard Algorithm Method" is that your 6th grader is referring to, even though you have an undergraduate degree in Math and an MBA, you meekly respond "Yes, Sweetie, that would seem to make sense normally, but you see, we cannot use the business owner's real salary. We have to use his or her Pretend Salary of $265,000, so we have to pretend the business owner is getting a 13.21% Profit Sharing allocation even though they are not. If we have a straight "Pro Rata Profit Sharing Allocation Method" called for in the plan document, then the business must contribute 13.21% for everyone!"

"No way, Dude!" your kid exclaims. "That's just crazy!" To which you respond, "Welcome to my world of a lot of IRS regulations that don't always make sense!"

Just so you know, with a Safe Harbor Cross Tested 401(k) Plan (wow, that is a mouthful!) for a successful small business, the contribution for the employees could be as low as approximately 4.40% (3% Safe Harbor plus 1.4% Profit Sharing) assuming the business owners are somewhat older than approximately 50% of the support staff.

For a nice handy, dandy chart of all of the 2015 retirement plan limitations including the Pretend Salary limit, go to this link: 401(k) Academy Materials and then click on the Retirement Plans Limitation Chart.

Annual Cost of Living Announcement Fest - A Satirical Explanation of the New Retirement Plan Limits

Each October brings three wonderful things - (1) Oktoberfest which according to Wikipedia is "the world's largest fun fair held annually in Munich, Bavaria, Germany. (2) Halloween which also according to Wikipedia is "a yearly celebration observed in a number of countries on 31 October, the eve of the Western Christian feast of All Hallows' Day. And (3) usually sandwiched somewhere in between these two annual diversions from working world drudgery is what I call the "Annual Cost-of-Living Announcement Fest". This is the time of the year when the IRS announces the various retirement plan limits and then every online newsletter writer and every retirement plan blogger races to be among the first to publish the limits in various places to be seen by their target audiences. 

Yep, the limits have been announced for 2015 and the Announcement Fest is in full swing - unfortunately it is just a bunch of boring numbers and no beer or chocolate included. So what do some of these numbers really mean and what relevance do they have to the real world. I won't bother to list all the limits here because by now you have saved 10 different charts of these. Oh, okay, if you really need another chart to print go here: http://401kacademy.com/materials/ and then click on the Retirement Plans Limitations Chart.

Back to what these limits mean... The first one I will discuss must depress the heck out of the great majority of 401(k) and 403(b) participants - they are now being told that they can save $18,000 in salary deferrals in 2015. Must be like an annual slap in the face to remind them how much the special, smart, successful top 1% of people in the old USA can save when they can barely afford to save anything at all. Then to add insult to injury, they are told if they are old enough (age 50 by 12/31/15) then they can save $24,000 ($18,000 plus $6,000 catch-up).

There is another group that must get frustrated as well when they see these annual salary deferrals limits and that is the group of so called Highly Compensated Employees (HCEs) who are not in a Safe Harbor Plan and so are not allowed to save the maximums either and in fact they keep getting money kicked back to them with some sort of innocuous explanation from HR about something called the "failed ADP test."

In a nutshell, some of the most pertinent limits are: Salary Deferrals $18,000; Catch-up Deferrals $6,000; Total Limit from All Contributions (deferral, match, Profit Sharing, forfeitures allocated, etc. $53,000 (add $6,000 Catch-up if over 50); amount of compensation that can be counted $265,000; amount of compensation in 2015 that will make you a Highly Compensated Employee in 2016 is $120,000 and the new Social Security Taxable Wage Base $118,500. Hey at 15.3% combined for employee and employer, that's over $18,000 being paid into Social Security in one year.

Again, see the link in my second paragraph above for all the limits in a nice, organized chart form. Heck, we even colored every other line for your viewing pleasure.

A Novel Idea for Promoting Retirement Savings - But It Will Never Happen

Like Don Quixote and Sancho Panza railing against the Windmills in the Spanish novel, The Ingenious Gentleman Don Quixote of La Mancha, here I am as a lonely and deranged TPA railing against Government retirement plan regulations. Caveat:  if you are super busy, go on to your other work because I am just tilting at Windmills here and not expecting to teach you anything or give you any valuable ideas to implement, so I have broken the first rule of social media postings. Perhaps you will find my idea entertaining or interesting if you do decide to read on.  

As a Third Party Administrator for 40 years, my life has been all about compliance, compliance and more compliance. Over the years, more and more required Notices have been forced upon the retirement plan administration industry (or more properly, upon Plan Sponsors).

We have the annual ADP test, designed, I guess, to force the Plan Sponsor to promote the 401(k) plan better with the rank-in-file employees. We have to make sure participants are given a Summary Annual Report (SAR). Please, someone (anyone!) explain to me what the SAR accomplishes in the real world! Then there is the Safe Harbor Notice, the EACA Notice, the QDIA Notice, the 404a5 Fee Disclosure Notices, etc., etc. If I was to do a complete listing, it would be too long and nobody would finish reading my blog posting.

Thinking about all of these Notices and all of the compliance work, it struck me that most everything is the Government's attempt to make employees aware of the retirement plan so that they will save for retirement. To implement and enforce all of this, the Plan Sponsors are expected to, company-by-company, develop effective communications and hold effective enrollment meetings to motivate people to engage in sufficient savings. Each financial institution doing record-keeping tries to create their own motivational enrollment books (that few participants actually read) and develop websites loaded with savings tools (that nobody uses). The Government hires many people to oversee everything (do audits, invent new notices, etc.) and that also does little or nothing to solve the dramatic savings shortfall. My years of observation tells me that all of the above efforts do not work very well! Savings rates are still abysmal.

How about a completely new, outside of the box, approach? Let's redirect some of the enforcement and audit dollars of the Government to developing a few really, really good movies or videos that can properly communicate about the wisdom of saving. Hire the best creators and movie makers from Hollywood to craft the message.  Get some A-list actors and actresses to volunteer their time "for the good of America." (yea, right!)

I am betting a team of professional screen writers, combined with professional directors and actors could come up with a handful of really effective short videos or movies that could actually educate and motivate the average participant to get off their butts and start saving. Create a movie showing a saver and a non-saver later in life - you know, at retirement. One struggling to make ends meet and one enjoying life based on decisions they made about saving years ago.  Instead of Plan Sponsors inventing their own education, just have them host meetings (on company time) to screen the movies or videos. Have record-keepers build prominent links to the movies on their websites. Pay NetFlix and Amazon to host the movies for free. Throw some advertising dollars into the promotion.  And consider even doing some rap videos - have some rap star rail against the stupidity of not doing something for the family.  You get my drift - do anything but a boring enrollment book nobody will read.

In other words, make really, really good effective, motivational movies or videos and then promote the heck out of them. Or is that just too simple of an idea?  Small plan sponsor will never fork over their hard earned dollars for the superb videos already available from some for-profit companies.

Yeh! You're right - that is crazy thinking - let's just force a few more inane notices upon everyone.  That will work! Right?