Over-50 Catch-Up Contributions

For those who will reach age 50 before the year’s end, the limit on the amount you may contribute to a 403(b), 401(k), or 457 account increases by $6,000. This boosts the individual contribution limit from $18,500 to $24,500. 

General Breakdown of 401(k)s, 403(b)s, and 457 Plans 
When it comes to comparing 401(k)s, 403(b)s, and 457 plans, there are many similarities and few differences. The similarities include: 

• $18,500 contribution limit (2018);
• $6,000 over-50 catch-up contribution; 
• Risk of investing falls on employee; 
• Withdrawals taxed as ordinary income; and 
• Amounts deferred on a pre-tax basis. 

 The major differences include: 

• 403(b)s and 457s have additional catch-up deferrals, as discussed above; 

• 401(k)s are open to most employers, 403(b)s are open to tax-exempt and non-profit organizations, and 457s are open to state/local governments and some non-profit organizations; and  
• 457 plans may not be subject to early withdrawal penalties like 403(b)s and 401(k)s. 

Mingling Contributions Among 401(k)s, 403(b)s, and 457 Plans

If you have a 401(k) and a 403(b), the maximum amount you can contribute to both accounts combined is $18,500 (2018). If you have a combination of a 401(k) and/or a 403(b) paired with a 457 plan, the maximum you can contribute combined is $37,000: $18,500 to the 401(k) and/or 403(b) and $18,500 to the 457. Plus, you can make any catch-up contributions allowed. The money you save into each account should be in order of employer matching with the employer plan that matches you at the highest rate first, until the match is completely maximized; then the money should flow to the account with the second-best matching and so on until you have contributed your overall maximum contribution to all plans. 

DEDUCTIBILITY OF PENSION PLAN CONTRIBUTIONS

Excessive contributions to a pension plan fund, if they are allowed to be deducted, will accelerate the employer's tax deduction and thereby increase the tax benefit of the qualified plan beyond what is considered appropriate. To prevent this, there are specific limits on the amount of pension plan contributions that an employer can deduct in a given plan year.

Unlike the deduction limit for profit-sharing plans, which is 15 percent of payroll ), the deduction limit for pension plans is based on actuarial considerations. For a given plan year, an employer can deduct contributions to a pension plan up to a limit determined by the largest of three amounts [Code Section 404(a)(1)].

1. The amount necessary to satisfy the minimum funding standard for the year.
2. The amount necessary to fund benefits based on past and current service on a level funding basis over the years remaining to retirement for each employee. However, if the remaining unfunded cost for any three individuals is more than 50 percent of the total of the unfunded costs, fundings for those three individuals must be distributed over a period of at least five taxable years.
3. An amount equal to the normal cost of the plan plus, if there is a supplemental liability, an amount necessary to amortize the supplemental liability in equal annual payments over a ten-year period.

In determining the applicable limitation, the funding methods and the actuarial assumptions used must be the same as those used for purposes of the minimum funding standards. Furthermore. the tax deduction for a given plan year cannot exceed the full funding limitation that was discussed earlier. Thus, there is little incentive for the employer to contribute beyond the full funding limitation.

Although these limits are expressed in actuarial language, the implications are relatively easy to understand. First of all, if the plan is funded on the basis of individual insurance contracts, the second limit will generally be the one applicable to the plan because most such contracts have premiums determined on the basis of level funding for the years remaining until retirement for each employee. On the other hand, plans funded with group contracts and trust funds using a variety of actuarial methods and assumptions will generally be governed by the third alternative limit.

Note that this limit specifies the maximum deductible amount. The amount required to be contributed under the minimum funding standard as applied to the plan may be somewhat less than this limit. Therefore, in a given plan year, the employer's actual contribution and deduction may be less than the maximum limit that applies. This is one of the reasons why a defined-benefit plan with a group pension contract or trust fund can be relatively flexible for the employer. Between the minimum limit required by the minimum funding standards and the maximum deductible limit discussed earlier, there may be a relatively comfortable range of contributions that can be adjusted according to the employer's specific financial situation.

Technically, the rules previously stated apply to both defined-benefit and defined-contribution pension plans. However, for defined-contribution plans, the minimum funding standards are satisfied whenever the employer makes the annual contributions specified by the plan document. In other words, the limit on the amount deductible under a defined-contribution pension plan is simply the amount specified in the plan document. For example, the plan document in a money-purchase plan might require that each year the employer must contribute an amount equal to 6 percent of each employee's compensation to that employee's account. The total of such contributions would then be both the amount required by the minimum funding standard and the maximum amount deductible.

If an employer has a combination of defined-benefit and defined-contribution plans covering the same employee or employees, a percentage deduction limit applies. The deduction for a given year cannot exceed the greater of 25 percent of the common payroll (compensation of employees covered under both plans) or the amount required to meet the minimum funding standard for the defined-benefit plan alone. This provision has its greatest impact on highly compensated employees.

Penalty for Nondeductible Contributions
Generally, there is no advantage in contributing more to a plan than is deductible, because not only is the deduction for the excess unavailable but under Code Section 4972, a 10 percent penalty is imposed on the nondeductible portion of the contribution, with some exceptions. However, if nondeductible contributions are made, they can be carried over and deducted in future years. The deduction limit for future years, however, applies to the combination of carried-over and current contributions.

Timing of Deductions
The rules for timing of contributions and deductions for qualified plans are relatively favorable. Contributions will be deemed to be made by the employer for a given taxable year of the employer, and will be deductible for that year, if they are made by the time prescribed for filing the employer's tax return for that year, including extensions. For example, a corporation using a calendar year could contribute to the plan for 2001 as late as September 15, 2002 (the basic tax filing date of March 15, plus the maximum six-month extension). The rules for timing of contributions and deductions are the same for both cash and accrual-method taxpayers; there is no advantage for this purpose in using the accrual method.

MEDICAL SAVINGS ACCOUNTS : Contributions & Distributions

Contributions
Either the account holder of an MSA or the account holder's employer, but not both, may make a contribution to an MSA. If the employer makes a contribution, even one below the allowable limit, the account holder may not make a contribution. Contributions must be in the form of cash.

Contributions by an employer are tax deductible to the employer and are not included in an employee's gross income or subject to Social Security and other employment taxes. Employee contributions are deductible in computing adjusted gross income. As with IRAs, individuals' contributions must generally be made by April 15 of the year following the year for which the contributions are made.

The amount of the annual deductible contribution to an employee's account is limited to 65 percent of the deductible for the health coverage if the MSA is for an individual. The figure is 75 percent if an MSA covers a family. If each person in a married couple has an MSA and if one or both of the MSAs provide family coverage, the aggregate deductible contribution is equal to 75 percent of the deductible for the family coverage with the lowest deductible. The deductible contribution is split equally between the two persons in the couple unless they agree to a different division.

The actual MSA contribution that can be deducted is limited to 1/12 of the annual amount, as described in the previous paragraph, times the number of months that an individual is eligible for MSA participation. For example, assume that the deductible under an individual's health plan is $1,800. The maximum annual contribution to the MSA is then 65 percent of this amount, which is $1,170, and the monthly amount is $97.50. If the individual is covered under a high-deductible plan for only the first eight months of the year, then the annual deductible contribution is eight times $97.50, or $780. Note, however, that there are no requirements that contributions be made on a monthly basis or at any particular time. In this example, the full $1,170 could have been made early in the year. The excess over $780 would then be an excess contribution.

An excess contribution occurs to the extent that contributions to an MSA exceed the deductible limits or are made for an ineligible person. Any excess contribution made by the employer is included in the employee's gross income. In addition, account holders are subject to a 6 percent excise tax on excess contributions for each year these contributions are in an account. This excise tax can be avoided if the excess amount and any net income attributable to the excess amount are removed from the MSA prior to the last day prescribed by law, including extensions, for filing the account holder's income tax return. The net income attributable to the excess contributions is included in the account holder's gross income for the tax year in which the distribution is made.

An employer that makes contributions to MSAs is subject to a comparability rule that requires the employer to make comparable contributions for all employees who have MSAs. However, full-time employees and part-time employees (those working fewer than 30 hours per week) are treated separately. The comparability rule requires that the employer contribute either the same dollar amount for each employee or the same percentage of each employee's deductible under the health plan. Failure to comply with this rule subjects the employer to an excise tax equal to 35 percent of the aggregate amount contributed to MSAs during the period when the comparability rule was not satisfied.

Growth of MSA Accounts
Unused MSA balances carry over from year to year, and there is no prescribed period in which they must be withdrawn. Earnings on amounts in an MSA are not subject to taxation as they accrue.

Distributions
An individual can take distributions from an MSA at any time. The amount of the distribution can be any part or all of the account balance. Subject to some exceptions, distributions of both contributions and earnings are excludible from an account holder's gross income if used to pay medical expenses of the account holder and the account holder's family, as long as these expenses are not paid by other sources of insurance. For the most part, the eligible medical expenses are the same ones that would be deductible, ignoring the 7.5 percent of adjusted gross income limitation, if the account holder itemized his or her tax deductions. However, tax-free withdrawals are not permitted for the purchase of insurance other than long-term care insurance, COBRA continuation coverage, or health coverage while an individual receives unemployment compensation. In addition, in any year a contribution is made to an MSA, tax-free withdrawals can be made to pay the medical expenses of only those persons who were eligible for coverage under an MSA at the time the expenses were incurred. For example, MSA contributions cannot be withdrawn tax free to pay the unreimbursed medical expenses of an account holder's spouse who is covered under a health plan of his or her employer that is not a high-deductible plan.

Distributions for reasons other than paying eligible medical expenses are included in an account holder's gross income and are subject to a 15 percent penalty tax unless certain circumstances exist. The penalty tax is not levied if the distribution is made after the account holder turns 65 or because of the account holder's death or disability. In addition, the penalty tax does not apply to funds rolled over to a new MSA as long as the rollover is done within 60 days. Transfers of MSA accounts as a result of divorce are also tax free.

Estate Tax Treatment
Upon death, the remaining balance in an MSA is includable in the account holder's gross estate for estate tax purposes. If the beneficiary of the account is a surviving spouse, the MSA belongs to the spouse and he or she can deduct the account balance in determining the account holder's gross estate. The surviving spouse can then use the MSA for his or her medical expenses. If the beneficiary is anyone else, or if no beneficiary is named, the MSA ceases to exist.