Could 401(k) Contribution Limits Drop?
by Robert Powell
Monday, August 31, 2009
provided by MarketWatch.com


Contribution limits for 401(k)s and other plans may decrease next year

It's starting to seem like retirees and those saving for retirement can't catch a break.

First comes news that there won't be any cost-of-living increase for Social Security beneficiaries in 2010. Next we learn that beer prices are rising. And now we find that the maximum amount that you're allowed to contribute to your retirement plans may decrease next year.

"If recent inflation patterns continue into September, it's possible there will be a decrease in the statutory limits on qualified retirement-plan contributions and benefits for 2010," according to a report released by Mercer, the consulting firm, this week.

According to Mercer, the limits for defined-contribution and defined-benefit plans -- including the amount you can sock away in your 401(k) -- are adjusted each year according to a statutory formula based on inflation. And depending on actual inflation levels for August and September, Mercer said the formula could produce limits for 2010 that are lower than those currently in effect for 2009.

If that occurs, Mercer said employers will be looking to the IRS to decide whether the limits will remain unchanged or be reduced for 2010.

Presently, you can sock away up to $16,500 in your 401(k) on a pre-tax basis or $22,000 if you're age 50 and older. But given what's happened to inflation of late, Mercer said Uncle Sam could reduce the amount you sock away by $500, down to $16,000.

But it's worth noting a couple of things about that number.

1. Wrong Message

One, it would definitely send the wrong message if Uncle Sam actually reduced the amount you can set aside in your 401(k).

"I'm not sure that a decrease in the statutory limits is a good idea in this economic environment," said Richard Krasney of RJK Wealth Management. "The government should be rolling out more incentives for people to make contributions to retirement plans, not reducing the incentives."

Others agree. "A reduction in the limits would be yet another setback for workers struggling to rebuild their retirement savings in the wake of the financial crisis," said Mercer.

2. Few Save That Much Anyway

In reality, the decrease isn't all that significant when you look at the impact on individual workers, Krasney said. Very few Americans actually save the maximum allowed to their 401(k) plans. Workers with a 401(k) defer on average just 7% of their pay per year, or about $4,000 to $5,000 according to various research studies on the subject.

In other words, if Uncle Sam does reduce the amount workers can set aside, it will affect only a small percentage of workers, typically highly compensated employees and the most aggressive savers.

Should It Come to Pass

What if you're among those workers who might be affected should Uncle Sam decide to lower the contribution limits?

Bill McClain, a co-author of Mercer's report, said that once savers reach the deferral limit, they can save in other ways. For instance, he said, check whether your 401(k) plan allows after-tax contributions. In addition, you could -- even if the contribution might not be deductible -- set money aside in an IRA, or you could save more in a tax-efficient investment.

Krasney agreed, saying workers should continue to contribute as possible in order to save and avoid taxes on their earned income. "Over time, the market is likely to reward those with discipline," he said.

The IRS is expected to announce 2010 retirement plan limits on Oct. 15 -- the date the Bureau of Labor Statistics releases the September CPI-U. Keep your fingers crossed that Uncle Sam does right by those saving for retirement. In the meantime, a quick note to your lawmakers couldn't hurt either.

Robert Powell is the editor of Retirement Weekly.

Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.

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