Laymen Terms – Exclusion of Elective Deferrals From Deduction Limit

[Guest JimJ]

Can someone tell me in simple terms what has changed beginning in 2002 concerning elective deferrals? I have been told by our administrator that deferrals will no longer be counted towards the allowable deduction amount. What does this mean to us and how can it benefit our HCE’s. Thanks, JJ

[rcline46]

The tax law changed and elective deferrals are now considered employee deductions. Employer is limited to 25% of gross pay as a deduction (for all DC plans).

It has nothing to do with 401(k) testing so the effect on HCEs is nil. The fact that deferrals can be in 2002 100% of pay up to $11000 will mostly be good for non HCEs, but the results in the testing will help HCEs if any non's take advantage.

[Guest pineapple]

Prior to 2002, employers could make deductible contributions to defined contribution plans (profit sharing and 401(k)) of up to 15% of eligible compensation. The 15% contribution included both employer contributions and employee 401(k) deferrals.

For example, if a company had eligible compensation of $500,000, the maximum deductible contribution to the 401(k) plan was $75,000 ($500,000 x 15%). If employees made 401(k) deferrals of 10% ($50,000), that would only leave the employer room to make a profit sharing contribution of $25,000.

Effective in 2002, 401(k) deferrals will no longer count "against" the deduction limit. So, regardless of the amount that employees defer, the employer will be able to make a profit sharing contribution of 25% of eligible compensation.

This change can benefit the HCEs, especially in cross-tested plans.

Hope this helps.

[Guest AFRICA6796]

Excellent pineapple