published Wednesday, October 24th, 2012

Personal Finance: IRS increases contribution limits on retirement plans

Christopher A. Hopkins CFA

Good news for retirement savers: The IRS announced last Thursday that it was increasing contribution limits for most defined contribution plans and Individual Retirement Arrangements. Participants in employer plans will be allowed to defer up to $17,500 in 2013, an increase of $500 from this year. The increase in allowable deferrals applies to 401(k), 403(b), and most 457 plans and is a welcome if modest improvement.

The maximum contribution to an IRA account ratchets up to $5,500 next year.

The retirement plan landscape has changed dramatically over the past generation. The modern defined contribution plan was created in 1981 when the IRS formalized rules for salary deferral and employer matching provisions under section 401(k) of the internal Revenue Code. However, at that early date most of these plans were supplemental to an employer's basic defined benefit (pension) plan, and very few employees had a stand-alone 401(k) as their sole retirement option.

As defined contribution plans gained in popularity and concerns about budget deficits magnified, Congress acted in 1982 to reduce the total annual contribution limit from $45,475 to $30,000. This limit stood until 2001, when the Economic Growth and Tax Relief Reconciliation Act indexed the yearly

maximum contribution for inflation, and also loosened the limits on employee deferrals to allow for larger participant contributions.

Another important element of the 2001 reform was the initiation of so-called "catch-up" contributions for participants age 50 and over. The provision for 2013 allows qualifying catch-up contributions of up to $5,500 in addition to the deferral limit of $17,500, or a total of $23,000 next year.

IRA account holders may make an additional $1,000 catch-up contribution if they are 50 or older.

According to the Investment Company Institute, 61 percent of private-sector retirement plan assets were in traditional pensions in 1980. By 2011, the fraction of assets in pension plans had fallen to 34 percent covering fewer than 10 percent of private sector employees, highlighting the necessity of beefing up 401(k) participation.

The shift away from pensions presents a looming retirement crisis for many workers. Only half of all employees are covered by any plan at all, and those with 401(k) plans have accumulated just $60,000 on average, according to the Employee Benefit Research Institute. Obviously, more must be done to encourage participation, and recent developments like automatic enrollment are helping to get workers signed up earlier.

If you are currently enrolled, boosting contributions is the best investment you can make, if at all possible. Surveys report that only about 5 percent of 401(k) participants are making the maximum contribution. If you are not among them, make an effort to step up next year, even if only incrementally. Be sure you are contributing at least enough to maximize your employer's match, and then ratchet up your percentage every year as much as you are able.

Providing for a comfortable retirement is increasingly the responsibility of each of us individually. Resolving to work toward the maximum deferral is the best step you can take.

Christopher A. Hopkins CFA, is a vice president at Barnett & Co.

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