In 2021, the United States Senate recognized October as National Retirement Security Month.[1] In Senate Resolution 404, the Senate affirmed its support of the goals of National Retirement Security Month, which are to raise public awareness of 1) saving adequately for retirement and 2) the variety of tax-preferred retirement vehicles, most of which are underutilized in the United States. Additionally, the Senate called upon businesses and other community entities to implement programs designed to increase retirement savings and personal financial literacy.
Karr Barth Administrators has been an industry leader in the administration of non-qualified deferred compensation plans for nearly 50 years. We seek to help companies implement non-qualified plans that improve tax-deferred savings opportunities, restore benefits that are otherwise restricted by qualified plan limits and provide plan participants with leading investment options. To that end, we are heeding the Senate’s call and seeking to inform stakeholders about a potential remedy for the retirement income shortfall that qualified retirement plans might present to highly compensated employees.
Qualified vs. Non-Qualified Tax-Deferred Retirement Savings Plans
Qualified retirement plans, such as 401(k)s, adhere to requirements established by the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA). These requirements include, amongst other things, disclosure rules, minimum coverage standards, contribution limits, vesting rules, and participation tests (participation tests are generally designed to ensure that plans do not discriminate in favor of highly compensated employees). For 2024, the 401(k) contribution limit is $23,000 for employee contributions, and $69,000 for combined employee contributions and employer contributions. Employees aged 50 or older are eligible for “catch-up contributions” enabling them to contribute an additional $7,500, for an employee contribution limit of $30,500. The eligible 401(k) compensation limit is $345,000, which means that employers offering a 401(k) match are prohibited from applying the match to compensation above $345,000.
Non-qualified deferred compensation plans are typically offered by companies to attract, reward and retain their most critical employees whose needs cannot be met by qualified plans alone. These tax-deferred plans, the most popular of which are “401(k) Excess” plans, are intentionally exempt from ERISA guidelines but are required to adhere to rules set forth under Section 409A of the Internal Revenue Code. 401(k) Excess plans allow plan participants to voluntarily defer their compensation in amounts that exceed the contribution limits imposed on 401(k) plans and allow the company to apply a match to any amount of compensation.
401(k) Plan Shortfall
Conventional financial planning suggests retirees need 70%-80% of pre-retirement annual income each year in retirement to maintain a similar quality of life they had during their working years. For most workers, if they annually max out their 401(k) contributions and company matches and couple that with Social Security, they will be at or above the 70%-80% threshold. However, as employees begin to earn more compensation throughout their careers, the limitations of a 401(k), or other qualified plans, can have adverse consequences.
For example, the graph below depicts potential retirement income shortfalls that employees could experience at various salary levels. This graph assumes that an individual attempts to contribute 10% to their 401(k) plan subject to the annual limit, receives a 4% company matching contribution on eligible compensation, and receives Social Security payments in retirement. As shown, employees with salaries in excess of $200,000 can start to fall short the desired 70%-80% annual retirement income standard if they rely exclusively on their 401(k) and social security.
401(k) Excess Plan Advantages
Employees who max out their 401(k) contributions and company match opportunities routinely turn to conventional investment vehicles to supplement their retirement savings. These options may include brokerage accounts, mutual funds or other investment options. While these options may be appropriate for a wide variety of investors, they do not enjoy the same tax-deferred benefits as employer-sponsored retirement plans because the employee uses post-tax income to invest. Therefore, the employee is paying income tax on money they intend to invest; conversely, an employer-sponsored plan, such as a 401(k) Excess plan, enables an employee to lower their annual income tax burden and invest the entire pre-tax amount of compensation into the non-qualified plan. Furthermore, earnings on 401(k) Excess Plan accounts are tax-deferred. Employees pay ordinary income taxes only when their accounts are liquidated and paid back to them, typically in retirement.
Below is a graph that uses the same employee contribution assumptions as the previous graph, but also includes a 401(k) Excess plan to which an employee can defer income once they have reached 401(k) compensation or contribution limits. As depicted by green bars, these contributions to a 401(k) Excess plan can adequately address the retirement income shortfall for higher paid employees while maintaining a 10% deferral.
Although everyone has a different picture of an ideal retirement, Karr Barth shares these illustrations of how a 401(k) Excess plan can enhance an employee's projected retirement income to help our stakeholders better understand retirement preparedness. Companies can learn more about how they can implement a 401(k) Excess Plan at https://www.kbadmin.com.
[1] S.Res.404 — 117th Congress (2021-2022). Retrieved from: https://www.congress.gov/bill/117th-congress/senate-resolution/404/text
