2018 PEPRA compensation limits

The 2018 PEPRA compensation limits are $121,388 for Social Security members and $145,666 for non-Social Security members.

These limits are the maximum pay that a California public agency can recognize in a defined benefit plan for PEPRA members, i.e. those first hired by a public employer in 2013 or later.  “Classic” members hired from 1996 through 2012 are subject to the higher §401(a)(17) pay limit that applies to private sector employees.

Each year, the California Actuarial Advisory Panel (CAAP) publishes an “unofficial” calculation of the PEPRA compensation limit.  The 2018 limits are published on the State Controller’s Office website at Agenda Item #4 – Draft CAAP 2018 PEPRA Limit Letter November 21, 2017.

CalPERS usually publishes the limits in late February or early March.  The 2017 PERS notice is at https://www.calpers.ca.gov/docs/circular-letters/2017/200-010-17.pdf.  Update 1/16/2018: the 2018 PERS notice is at https://www.calpers.ca.gov/page/employers/policies-and-procedures/circular-letters.  Search for letter #200-001-18.

We’ve confirmed all of the PEPRA calculations in the CalPERS and CAAP letters.  Here is a complete set of the PEPRA compensation limits through 2018:

PEPRA Compensation Limit
Year Social Security Members Non Social Security Members
2013 113,700        136,440
2014 115,064        138,077
2015 117,020        140,424
2016 117,020        140,424
2017 118,775        142,530
2018 121,388        145,666

 

The Value of Tax Deferral

Happy couple

We often hear the question “why should I contribute to a qualified retirement plan if tax rates might go up”?  Good question; here’s why:  you’ll probably end up with more money after tax.  That’s true even if tax rates go up in the future.

How much more you’ll end up with depends on your investment return, the deferral period, and your marginal tax rates at three different times:

  • when you contribute the money,
  • while it’s invested, and
  • when you withdraw it.

The key is that in a taxable account, you lose some of the power of compound interest every time you’re taxed on your contributions and investment earnings.

Let’s start with a simple example, using a 33-1/3% marginal tax rate all the way through.  That’s a bit lower than the 35% top Federal rate, but it makes the math easy.  Suppose you have $3,000 to contribute, and investment earnings average 6%.

Tax deferred account / qualified plan

Contributing your $3,000 to a 401(k) or other qualified plan, you have the whole amount to invest and investment earnings are tax free – but you have to pay tax when you withdraw it.  Leaving it in for, say, 20 years you would have $6,414 after paying your tax:  $3,000 x (1.06 ^ 20) x (1-.3333).

Taxable account

Contributing to a taxable account, you have $2,000 to invest after tax ($3,000 x (1-.3333)) and investment earnings are taxable so your effective investment return is 4% (6% x (1-.3333)).  But then you’re done paying taxes.  After 20 years you would have $4,382:  $2,000 x (1.04 ^ 20).

What if’s:  rising tax rates, capital gains, return, deferral period, Roth

In this simple example, the qualified plan clearly beats the taxable account.  But what if tax rates are higher at withdrawal?  For the $4,382 in the taxable account to beat the qualified plan, the tax rate would have to suddenly jump to 54.5% at withdrawal:  $3,000 x (1.06 ^ 20) x (1-.545) = $4,378.   Any tax increase that happens more gradually would be worse for the taxable account, with no effect on the qualified plan.

What about capital gains?  If the current 15% long term capital gains rate is sustainable and all your investments qualify, your effective return is 5.1% (6% x (1-.15)).  You still start with $2,000 to invest after tax, so after 20 years you would have $5,408:  $2,000 x (1.051 ^ 20).  That’s not bad, but it’s still less than the $6,414 you would have had from a qualified plan.

What about different investment returns and deferral periods?  We’ve used 6% return for 20 years in this simple example, but how does it change for other returns and time periods?  The short answer is that higher investment returns and longer deferral periods favor the qualified plan.  Lower returns and shorter time favor the taxable account.

What about a Roth IRA or 401(k)?  As it turns out, Roth and regular 401(k) results are identical if your marginal tax rates are equal at contribution and withdrawal.  Roth is better if your marginal rate at withdrawal is higher than at contribution time; otherwise a regular 401(k) is better.  And they both blow the taxable account out of the water.

Deferred comp plans: when they’re a great choice, and when they’re not

Nonqualified deferred compensation plans are a common feature of executive pay packages.  They’re a great choice in the right conditions, i.e. when:Which door to choose?

  • The executive’s share of company profits is very small, and
  • The executive is willing to shoulder the employer’s credit risk, and
  • Providing the benefits through a qualified plan would be too expensive.

But they’re not so great when any of these conditions are missing.  Let’s examine each in turn.

Small share of company profits:  Nonqualified deferred compensation isn’t deductible for the company until it becomes taxable for the executive.  If the executive is a substantial owner in a profitable enterprise, e.g. a law firm or medical group partner, any deferred income boomerangs right back as taxable profit.  In contrast, qualified retirement plan contributions are deductible for the company when they’re made, and not taxable to the employee until they’re received in cash.

Willing to shoulder the employer’s credit risk:  Funding vehicles like rabbi trusts can protect the executive from the employer’s unwillingness to pay, but not against its inability to pay.  In today’s economic environment where even large companies are struggling, this risk may be unacceptable.  Protection from both of these risks – and even from the executive’s personal creditors – is provided by a qualified plan.

Qualified plan too expensive:  This is usually the main reason for setting up a deferred compensation plan.  Qualified plans have many requirements that don’t apply to most nonqualified plans:  coverage, nondiscrimination, government filings etc.  But they’re more flexible than most people realize.  In a cross-tested profit sharing/401(k) plan, top executives can often reach the annual $49,000 defined contribution limit with a 5% staff contribution.  And if that’s not enough, a cash balance or other defined benefit plan can allow much higher deductions:  up to an additional $100k-200k per year.

So, are we biased toward qualified plans?   Oh, absolutely.  Nonqualified plans can be a great choice, but make sure you’ve maximized your qualified plans first.

It’s now or never for ERRP application

We all knew this day would come, and now it’s here.  New applications for the Early Retiree Reinsurance Program (ERRP) will be received only until 5 pm on Thursday, May 5th.

The last time we blogged about this, the ERRP money was going fast.  Now the urgency is clear.

So if you’ve been thinking about applying, it’s now or never.   Elvis says so.

ERRP update: it’s time to make your move

In our last ERRP post, we noted that $1 billion of the original $5 billion in Early Retiree Reinsurance Program (ERRP) funds has been paid out.  Now, according to an article this week in Business Insurance, the US Dept of Health and Human Services (HHS) estimates that $3.6 billion will have been paid out in fiscal 2011 (ending 9/30/11).  That leaves only $1.4 billion for next year – and then it’s gone.

So, if you’re thinking about applying, it’s time to make your move.  The application process isn’t as bad as it initially appeared.  Our last ERRP post outlines how to go about it.

ERRP funds are going fast, but employers still have time to act

$1 billion of the original $5 billion has now been paid out under the Early Retiree Reinsurance Program (ERRP), according to an article this month in Business Insurance.

We’ve been watching the ERRP since its inception (posts 1, 2, 3, 4), and didn’t think the $5 billion allocation would last long. A July 2010 EBRI article estimated that it would last two years – and it might go even faster than that.   The EBRI article estimates the average reimbursement at about $2,000 per early retiree (Figure 4 on page 5: $2,544m / 1.3m = $1,957) – but there can be huge variations for  your own retiree group.

Many of our clients have applied for the ERRP and have been accepted. For employers that haven’t yet, there’s still time.  And the application process isn’t as onerous as it initially appeared.

Here’s what you need to do:

1. Check with your health insurer to see if you’re likely to have any individual early retiree claims above $15,000.  For midsize and large public-sector employers in Minnesota, Iowa, Indiana and Florida it’s almost a given – because subsidized early retiree coverage (the GASB 45 implicit rate subsidy) is mandated in those states.

2. Fill out and submit the ERRP application. Your health insurer can help with the trickiest parts of the application, i.e. cost control provisions and estimated reimbursements.

3.  Once your application is approved, follow the process on the ERRP website to obtain reimbursements. Your health insurer will have an important role in the reimbursement process, since you won’t usually know when you have an eligible claim.

 

$1 billion has now been paid out under the Early Retiree Reinsurance Program (ERRP), according to an article this month in Business Insurance http://www.businessinsurance.com/article/20110105/BENEFITS06/110109965.
We’ve been watching the ERRP since its inception (link to previous posts), and didn’t think the $5 billion allocation would last long.  A July 2010 EBRI article http://www.ebri.org/pdf/notespdf/EBRI_Notes_07-July10.Reins-Early.pdf estimated that it would last about two years – but it might go faster than that.

 

 

Many of our clients have applied for the ERRP and have been accepted.  For employers that haven’t yet, there’s still time.  And the application process isn’t as onerous as it initially appeared.
Here’s what you need to do:
1.  Check with your health insurer to see if you’re likely to have any individual early retiree claims above $15,000.  For midsize and large government employers in Minnesota, Iowa, Indiana and Florida it’s almost a given – because subsidized early retiree coverage (the GASB 45 implicit rate subsidy) is mandated in those states.
2.  Fill out the ERRP application www.errp.gov/download/ERRP_Application.pdf.  Your health insurer can help with the trickiest parts of the application, i.e. cost control provisions and estimated reimbursements.  The EBRI article http://www.ebri.org/pdf/notespdf/EBRI_Notes_07-July10.Reins-Early.pdf estimates this at about $2000 per early retiree (Figure 4 on page 5:  $2,544m / 1.3m = $1,957) – but there can be huge variations depending on your own retiree group.
3.  Once your application is approved, follow the process on the ERRP website www.errp.gov/index.shtml to obtain reimbursements.  Your health insurer will have an important role in the reimbursement process, since you won’t usually know when you have an eligible claim.

2011 IRS Pension Limits and Social Security Wage Base

The IRS just published the retirement plan limits for 2011.  Most of the limits for retirement plans are unchanged – again.  They’re the same as 2009 and 2010:

Maximum annual pension plan benefit

$195,000

Maximum annual addition for defined contribution plans

49,000

Maximum 401(k) elective deferral

16,500

Maximum catchup contribution (age 50 and over)

5,500

Highly compensated employee (HCE) threshold

110,000

Maximum annual recognized compensation

245,000

The Social Security wage base will also stay the same as 2009 and 2010, at $106,800.

Pension funding relief bill signed today

This just in:  President Obama signed the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act today.   Title I of the Act is about Medicare physician reimbursements, and Title II is about pension funding relief.

The funding relief is in the form of extended shortfall amortization periods.  Employers who choose to can take more than the usual seven years to pay off a funding deficit.

There’s a catch, though.  Several catches, actually.  If you take the relief, you have to notify the PBGC and all your plan participants.   And you have to make extra pension plan contributions if you pay any employee more than $1 million, pay extraordinary dividends or buy back an unusual amount of company stock.

Fixing a §401(a)(4) test failure

Our philosophy for coverage and nondiscrimination testing has always been “everything passes, some plans just take a little longer to prove it”.

That was put to the test recently for one of our law firm clients:  an unusually young new partner was causing their  §401(a)(4) nondiscrimination test to fail.  We emptied the whole toolbox on it, but nothing worked.  Thought we were out of luck.  Adding an extra contribution for all NHCE’s was going to be very expensive.

Ah, but wait!  The IRS came to the rescue with the §1.401(a)(4)-11(g) corrective amendment rules.  Within 9½ months after year end, we can amend the plan to give an extra allocation to a carefully selected group.  Problem solved, at very low cost.

Note that the amendment must have “substance”, i.e. provide real benefits for real people.  One that doesn’t is described in Suzanne Wynn’s blog here.  Nice try, creep…

There’s more detail in the regulations.  Go to paragraph (g) for corrective amendments.