2019 PEPRA compensation limits

The 2019 PEPRA compensation limits are $124,180 for Social Security members and $149,016 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 2019 limits are published on the State Controller’s Office website at Agenda Item #2 –PEPRA Pension Compensation Limit Letter for 2019.

CalPERS usually publishes the limits early in the calendar year.  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 the PEPRA calculations in the CalPERS and CAAP letters.  The table below shows a complete set of the PEPRA compensation limits through 2019.

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
2019 124,180 149,016

For PEPRA members in the CalSTRS Defined Benefit (DB), Defined Benefit Supplement (DBS) and Cash Balance (CB) Benefit programs, the 2018-19 pay limit is $146,230.  Each year’s adjustments are based on February CPI figures and the limits apply to fiscal years.  Since CalSTRS members aren’t included in Social Security, only the non-Social Security figures are shown in the table below.  CalSTRS publishes a similar table at https://www.calstrs.com/post/final-compensation.

Fiscal Year PEPRA Compensation Limit  for CalSTRS Members
2013-14 $136,440
2014-15 137,941
2015-16 137,941
2016-17 139,320
2017-18 143,082
2018-19 146,230

 

What’s the Effect of 2019 IRS Retirement Plan Limits?

IRS Notice 2018-83 just announced the 2019 retirement plan benefit limits, and there are many changes since 2018. What does it all mean for employer-sponsored retirement plans? Here is a table of the primary benefit limits, followed by our analysis of the practical effects for both defined contribution (DC) and defined benefit (DB) plans.

Qualified Plan Limit 2017 2018 2019
415 maximum DC plan annual addition $54,000 $55,000 $56,000
Maximum 401(k) annual deferral $18,000 $18,500 $19,000
Maximum 50+ catch-up contribution $6,000 $6,000 $6,000
415 maximum DB “dollar” limit $215,000 $220,000 $225,000
Highly compensated employee (HCE) threshold $120,000 $120,000 $125,000
401(a)(17) compensation limit $270,000 $275,000 $280,000
Social Security Taxable Wage Base $127,200 $128,400 $132,900

 

 Changes affecting both DB and DC plans

  • Qualified compensation limit increases to $280,000. This is a similar increase to recent years, so highly-paid participants will now have more of their compensation “counted” towards qualified plan benefits and less towards non-qualified plans. This could also help plans’ nondiscrimination testing if the ratio of benefits to compensation decreases.
  • HCE compensation threshold increases to $125,000. It’s nice to have an increase after several years of a stagnant $120,000 limit. Employers may find that slightly fewer participants meet the new HCE compensation criteria, which could have two direct outcomes:
    • Plans may see marginally better nondiscrimination testing results (including ADP results) if there are fewer HCEs. It could potentially make a big difference for smaller plans that were very close to failing the tests.
    • Fewer HCEs means that there are fewer participants who must receive 401(k) deferral refunds if the plan fails the ADP test.

Note that there is a “lookback” procedure when determining HCE status. This means that the 2020 HCEs are determined based on whether their 2019 compensation is above the $125,000 threshold.

 

DC-specific increases and their significance

  • The annual DC 415 limit increases from $55,000 to $56,000 and the 401(k) deferral increases to $19,000. Savers will be glad to have more 401(k) deferral opportunity, albeit a modest $500 increase. Even though these deferrals count towards the total DC limit, employers can also increase their maximum profit sharing allocations. Individuals could potentially get up to $37,000 from employer matching and profit sharing contributions ($56K – $19K) if they maximize their DC plan deductions.
  • 401(k) “catch-up” limit remains at $6,000. Participants age 50 or older still get a $6,000 catch-up opportunity in the 401(k) plan, which means they can effectively get a maximum DC deduction of $62,000 ($56K + $6K).

 

DB-specific increases and their significance

  • DB 415 maximum benefit limit (the “dollar” limit) increases to $225,000. This is the third straight year we’ve seen an increase in the DB 415 limit after three years of static amounts. The effect is that individuals who have very large DB benefits (say, shareholders in a professional firm cash balance plan) could see a deduction increase if their benefits were previously constrained by the 415 dollar limit.

 

Social Security wage base and integrated plans

  • Social Security Taxable Wage Base increases to $132,900. This is a substantive $4,500 increase from the prior limit. A higher wage base can reduce the rate of pension accruals and DC allocations for highly-paid participants in integrated pension and profit sharing plans that provide higher rates above the wage base.

Professional Firm Retirement Plans and the New QBI Tax Deduction

Qualified retirement plans were a good deal before the December 2017 Tax Cuts and Jobs Act.  For many professional firms, they’re now better than ever.

Here’s the new part:  many owners of pass-through businesses like S corporations, LLCs and sole proprietors are eligible for a 20% deduction on Qualified Business Income (QBI), essentially non-W2 business income (profits).

For “specified service businesses”, i.e. most professional firms, the 20% deduction is limited in 2018 for owners with income of more than $315,000 (married) or $157,500 (single) [1].  It’s completely eliminated for owners with income of more than $415,000 (married) or $207,500 (single).

If your income is below the threshold, you’re eligible for the entire 20% deduction.  If your income is too high, retirement plan contributions can bring it down below the threshold.

The combined effect of the retirement plan and QBI deductions can be astonishing.

Let’s take the example of Rachel, a 50 year old married partner in a successful LLC.  Her share of the firm’s profits is $376,000.  If she maximizes her 401(k) deferral and the firm maximizes her profit sharing contribution (total of $61,000 with catchup), her income has dropped to $315,000.  She’s entitled to the $61,000 deduction and, in addition, she can now deduct the entire 20% of QBI.  The table below shows how it works:

 With 401(k)/ PS Contribution

 Without 401(k)/ PS Contribution

 Income before contribution [2]

 $  376,000

 $   376,000

 Retirement plan deduction

      (61,000)

              –  

 Income before QBI deduction

     315,000

      376,000

 QBI deduction
 Full deduction percentage

20%

20%

 Adjusted % (phase-out)

20.00%

7.80%

 Deduction amount

       63,000

        29,328

 Federal income tax (FIT) [3]

       43,299

        66,634

 FIT savings

 $    23,335

By contributing $61,000 to her own retirement account, Rachel has reduced her 2018 taxable income by $94,672 and her federal income taxes by $23,335.  And that doesn’t even include her savings in FICA or state & local income taxes.

What if Rachel’s firm is even more successful, so that her share of the profits is $526,000?  With the right demographics, it’s still possible to contribute enough to bring her income down to the $315,000 threshold.  To do that she’ll need a cash balance plan, which works especially well for professional firms.  Partners around age 50 can contribute up to $150,000 – in addition to the $61,000 401(k)/profit sharing contribution.  Older partners can contribute more than that: up to $280,000 cash balance at age 62 – for a total contribution of $341,000 (!) with 401(k) and profit sharing.

The next table shows this scenario for Rachel:

 With
Cash Balance and 401(k)/PS Contribution

 Without
Cash Balance and 401(k)/PS Contribution

 Income before contribution [2]

 $     526,000

 $      526,000

 Retirement plan deduction

       (211,000)

                 –  

 Income before QBI deduction

        315,000

         526,000

 QBI deduction
 Full deduction percentage

20%

20%

 Adjusted % (phase-out)

20.00%

0.00%

 Deduction amount

          63,000

                 –

 Federal income tax (FIT) [3]

         43,299

         127,079

 FIT savings

 $       83,780

This time, Rachel has reduced her 2018 taxable income by $274,000 and her federal income taxes by $83,780 by contributing $211,000 to her own retirement accounts.  And that still doesn’t include her savings in FICA or state & local income taxes.

Qualified retirement plans have always been a sweet deal for professional service firms.  And they just got a lot sweeter.

At this writing (October 2018), there are just a couple months left to set up a plan for 2018.  You’ll need to run some numbers, make the necessary plan design decisions and have a signed plan document in place by December 31.  Just let us know if you’d like to take a look.

 

[1] It’s also limited to 50% of W2 pay in many cases.  We’ve chosen a partnership-taxed LLC to simplify this example.

[2] Assuming the same non-owner retirement plan contributions in both columns.  In real life, non-owner contributions are an important plan design component – but we’ve simplified them here.

[3] Simplified calculation ignoring AMT and non-standard deductions.

CERBT Audited vs. Reported Assets

For most California public agencies funding Other Post-Employment Benefits (OPEB) through CERBT, there is a small difference between the 6/30/2017 assets originally reported and the final audited assets (Fiduciary Net Position, or FNP).  Our clients have been asking what to do about it.

Even the State of California has the same issue.  We’ve discussed it with the State Controller’s Office, and they’ve chosen to go with the amount originally reported by CERBT for the State’s CAFR.

Many of our clients have chosen the State’s approach, because their OPEB actuarial valuations were completed before the audited assets were announced by CalPERS in a 3/27/2018 circular letter.

Most of the differences in audited vs. reported assets are quite small.  Your options include:

  1. using the CERBT assets originally reported, or
  2. waiting to finalize your OPEB actuarial valuation until audited CERBT assets are available.

If you ever want to change from option 1 to option 2 (or vice versa), you’ll need a one-time adjustment to your FNP reconciliation.  Either way, you’ll want to check with your auditor.

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

What’s the Impact of 2018 IRS Retirement Plan Limits?

The IRS Notice 2017-64 just announced the 2018 retirement plan benefit limits, and there are many changes since 2017. What does it all mean for employer-sponsored retirement plans? Below is a table summarizing the primary benefit limits, followed by our analysis of the practical effects for both defined contribution (DC) and defined benefit (DB) plans.

Qualified Plan Limit 2016 2017 2018
415 maximum DC plan annual addition $53,000 $54,000 $55,000
Maximum 401(k) annual deferral $18,000 $18,000 $18,500
Maximum 50+ catch-up contribution $6,000 $6,000 $6,000
415 maximum DB “dollar” limit $210,000 $215,000 $220,000
Highly compensated employee (HCE) threshold $120,000 $120,000 $120,000
401(a)(17) compensation limit $265,000 $270,000 $275,000
Social Security Taxable Wage Base $118,500 $127,200 $128,400

 Changes affecting both DB and DC plans

  • Qualified compensation limit increases to $275,000. Highly-paid participants will now have more of their compensation “counted” towards qualified plan benefits and less towards non-qualified plans. This could also help plans’ nondiscrimination testing if the ratio of benefits to compensation decreases.
  • HCE compensation threshold remains at $120,000. This is the fourth year in a row that the HCE compensation limit has been stuck at $120,000. When this threshold doesn’t increase to keep pace with employee salary increases, employers may find that more of their employees become classified as HCEs. This could have two direct outcomes:
  • Plans may see marginally worse nondiscrimination testing results (including ADP results) if more employees with large deferrals or benefits become HCEs. It could make a big difference for plans that were previously close to failing the tests.
  • More HCEs means that there are more participants who must receive 401(k) deferral refunds if the plan fails the ADP test.

Note that there is a “lookback” procedure when determining HCE status. This means that the 2019 HCEs are determined based on whether their 2018 compensation is above the $120,000 threshold.

DC-specific increases and their significance

  • The annual DC 415 limit increases from $54,000 to $55,000 and the 401(k) deferral increases to $18,500. Savers will be glad to have more 401(k) deferral opportunity, albeit a modest $500 increase. Even though these deferrals count towards the total DC limit, employers can also increase their maximum profit sharing allocations. Individuals could potentially get up to $36,500 from employer matching and profit sharing contributions ($55K – $18.5K) if they maximize their DC plan deductions.
  • 401(k) “catch-up” limit remains at $6,000. Participants age 50 or older still get a $6,000 catch-up opportunity in the 401(k) plan, which means they can effectively get a maximum DC deduction of $61,000 ($55K + $6K).

DB-specific increases and their significance

  • DB 415 maximum benefit limit (the “dollar” limit) increases to $220,000. This is the second straight year we’ve seen an increase in the DB 415 limit, after three years of static amounts. The primary impact is that individuals who have very large DB benefits (say, shareholders in a professional firm cash balance plan) could see a deduction increase if their benefits were previously constrained by the 415 dollar limit.
  • Social Security Taxable Wage Base increases to $128,400. This is a modest $1,200 increase from the prior limit. With regards to qualified retirement benefits, a higher wage base can slightly reduce the rate of pension accruals for highly-paid participants in integrated pension plans that provide higher accrual rates above the wage base. [Note: the taxable wage base was originally published as $128,700 by the Social Security Administration in October 2017 but later updated to $128,400 in November 2017.]

What’s the Impact of 2017 IRS Retirement Plan Limits?

The IRS just announced the 2017 retirement plan benefit limits, and there are some notable changes from 2016. What does it all mean for employer-sponsored retirement plans? Here is a table summarizing the primary benefit limits, followed by our analysis of the practical effects for both defined contribution (DC) and defined benefit (DB) plans.

Qualified Plan Limit 2015 2016 2017
415 maximum DC plan annual addition $53,000 $53,000 $54,000
Maximum 401(k) annual deferral $18,000 $18,000 $18,000
Maximum 50+ catch-up contribution $6,000 $6,000 $6,000
415 maximum DB “dollar” limit $210,000 $210,000 $215,000
Highly compensated employee (HCE) threshold $120,000 $120,000 $120,000
401(a)(17) compensation limit $265,000 $265,000 $270,000
Social Security Taxable Wage Base $118,500 $118,500 $127,200

 

Changes affecting both DB and DC plans

  • Qualified compensation limit increases to $270,000. High-paid participants will now have more of their compensation “counted” towards qualified plan benefits and less towards non-qualified plans. This could also help plans’ nondiscrimination testing if the ratio of benefits to compensation decreases.
  • HCE compensation threshold remains at $120,000. For calendar year plans, this will first affect 2018 HCE designations because $120,000 will be the threshold for the 2017 “lookback” year. When the HCE compensation threshold doesn’t increase to keep pace with employee salary increases, employers may find that more of their employees become classified as HCEs. This could have two direct outcomes:
    • Plans may see marginally worse nondiscrimination testing results (including ADP results) if more employees with large deferrals or benefits become HCEs. It could make a big difference for plans that were previously close to failing the tests.
    • More HCEs means that there are more participants who must receive 401(k) deferral refunds if the plan fails the ADP test.

DC-specific increases and their significance

  • The annual DC 415 limit increases from $53,000 to $54,000 and the 401(k) deferral limit remains at $18,000. A $1,000 increase in the overall DC 415 limit may not seem like much, but it will allow participants to get a little more “bang” out of their DC plan. Since the deferral limit didn’t increase, this means that any additional DC benefits will have to come from higher employer contributions. Individuals can now receive up to $36,000 from match and profit sharing contributions ($54K – $18K).
  • 401(k) “catch-up” limit remains at $6,000. Participants age 50 or older still get a $6,000 catch-up opportunity in the 401(k) plan, which means they can effectively get a maximum DC deduction of $60,000 ($54K + $6K).

DB-specific increases and their significance

  • DB 415 maximum benefit limit (the “dollar” limit) increases to $215,000. This limit finally increased after being static for three straight years. The primary impact is that individuals who have very large DB benefits (say, shareholders in a professional firm cash balance plan) could see a deduction increase if their benefits were previously constrained by the 415 dollar limit.
  • Social Security Taxable Wage Base increases to $127,200. This is a big jump from the prior $118K limit and effectively reflects two years of indexing (the limit couldn’t increase last year because the Social Security COLA was 0% and caps the wage base increase rate). With regards to qualified retirement benefits, a higher wage base can slightly reduce the rate of pension accruals for highly-paid participants in integrated pension plans that provide higher accrual rates above the wage base.

 

Developing a thoughtful public pension funding policy

A thoughtful pension funding policy provides the best way for public sector employers to keep their pension promises. The funding policy provides discipline to address unfunded pension liabilities, while respecting the many current demands for budget dollars.

The League of Arizona Cities and Towns recently sponsored a study by a special Task Force to identify areas for improvement and develop reform recommendations. The final recommendation is “Create a pension funding policy.” The Task Force emphasized that Arizona cities and counties “have a fiduciary responsibility to ensure (the) plan has sufficient financial resources to provide the benefits earned ….”

The pension funding policy is the best (and maybe the only) way for plan sponsors to meet their fiduciary duty to keep the pension promise. But developing a pension funding policy is not easy. It requires projecting unfunded pension liabilities beyond what is usually shown in existing actuarial reports. It also requires a delicate balancing of all of the various constituent interests over a variety of time frames.

The easy way out has always been to ignore the problem and leave it to someone else in the future. But a prudent few will openly address the political and budget issues inherent in developing a funding policy that keeps the pension promise.

One city recently chose to invest the time and resources to develop a pension funding policy. After years of declining funded ratios and increasing contributions, the city Finance Officer championed a study that involved the City Commission, the pension fund members, the actuary and the investment advisor. The resulting pension funding policy provided for an increase in employer and employee payroll contributions – and also provided for a third stream of contributions unrelated to payroll: a pension sustainability contribution.

We encourage every public sector plan sponsor to develop a pension funding policy. And we applaud the prudent finance officers who actually begin the process to keep their pension promises.

Public Safety Benefits Can Significantly Affect OPEB Liabilities

Federal, state and local regulations often include mandated health benefits for officers disabled in the line of duty. These benefits are a way to reward officers for protecting and serving the public at great risk of bodily harm. The value of these benefits must be accounted for under GASB accounting rules, and there are a few important considerations when doing so.

Important considerations for OPEB plans:

– Determining the implicit rate subsidy (health cost in excess of the average premium). This may include expected health care costs for disabled officers that are significantly higher than for non-disabled individuals.  Another factor to consider is whether or not disabled officers are Medicare-eligible. If so, how does that reduce the expected health care costs?

– Determining the direct subsidy (portion of the premium paid by the employer).  This is the premium cost not only for disabled officers, but also for dependents.

– Length of benefit coverage. Unlike regular retiree health care which can begin around age 50 to 55 for officers, disability health care begins much earlier.  Often officers disabled in the line of duty are in their 30’s and 40’s.

The earlier start creates significant additional costs.  For example, the direct subsidy for a disabled officer age 40 could exceed $150,000 ($6,000 in premium per year for 25 years) – and this does not include any costs for dependent coverage or the implicit subsidy. Read more…

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.