2008 INFLATION INCREASES MAY IMPACT EMPLOYERS

Posted 12/12/07

Every year, inflation adjustments are made to many of the federal tax law limits on retirement plan contributions and benefits. In addition, the new year also sees changes to limits applicable to Social Security. Here is a rundown of what does - and what does not - change for 2008.

What Doesn't Change

No inflation adjustments were made to the following items:

Elective Deferrals.  The annual dollar limit on employee elective deferrals to 401(k) salary deferral plans, 403(b) annuities, and governmental 457 plans remains $15,500 for 2008.

SIMPLE Plans.  The maximum amount an employee may defer under a SIMPLE retirement plan remains $10,500 for 2008.

Catch-up Contributions.  Additional "catch-up" contributions may be made to certain retirement plans by participants age 50 or older. The annual dollar limit for catch-up contributions to a 401(k), 403(b), or governmental 457 plan remains $5,000 in 2008. For SIMPLE plans, the limit remains $2,500.

What Does Change

The following inflation-related changes to the retirement plan limits go into effect starting January 1, 2008.

Defined Contribution Annual Addition Limit.  The limit on "annual additions" (that is, employee contributions, employer contributions, and forfeitures) that may be made to a plan participant’s account in a defined contribution plan (such as a 401(k) plan or a profit sharing plan) increases from $45,000 to $46,000. Thus, more money can be added to a participant’s plan account in 2008.

Annual Compensation Limit  The maximum amount of annual compensation that can be used in computing retirement plan contributions or benefits for a participant rises from $225,000 to $230,000.

Highly Compensated Employee Definition  A qualified plan may not discriminate in favor of "highly compensated employees." The dollar limit used in defining a highly compensated employee increases from $100,000 to $105,000 for 2008.

Key Employee Definition  Another nondiscrimination rule provides that "top heavy" plans (generally, those in which more than a specified percentage of plan assets are in the accounts of "key employees") meet special requirements. The definition of "key employee" includes a compensation amount above which an employee is considered "key." That amount increases from $145,000 to $150,000 a year.

ESOP Five-year Distribution Period Qualification.  Generally, a participant in an Employee Stock Ownership Plan (ESOP) who separates from service can spread distribution of the account balance up to five years. To the extent the balance exceeds a certain dollar amount - $935,000 in 2008, up from $915,000 - the participant might have additional time for distribution. The distribution period is extended by one year for each $185,000 (up from $180,000), or a fraction of that amount, by which the account balance exceeds $935,000.

Defined Benefit Limit.  The limit on the annual benefit to be funded under a defined benefit pension plan rises from $180,000 to $185,000.

Social Security Tax-related Increase

The FICA tax (essentially, the combination of Social Security tax and Medicare tax) is imposed at a rate of 7.65% each for employers and employees (6.2% for Social Security tax, 1.45% for Medicare tax). For self-employed persons, the FICA tax is doubled to 15.3%. The Social Security portion is imposed on a limited "wage base" amount, adjusted each year based on average U.S. total wages. The Medicaid tax component is imposed on the full amount of wages paid.

For 2008, the Social Security Administration has increased the Social Security wage base to $102,000, up from $97,500 in 2007.

What does this mean to employers and employees? On wages of $102,000 or more, the employer and employee will each pay $279 more in Social Security tax ($6,324 versus $6,045) in 2008 than in 2007.

The self-employed worker with at least $102,000 in net self-employment earnings will pay $558 more as the Social Security tax portion - $12,648 in 2008 versus $12,090 in 2007.

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For more information about these changes and how they may affect your business, please contact one of our knowledgeable professionals. We’re here to help.

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To ensure compliance with requirements imposed by the U.S. Department of the Treasury and the IRS, we inform you that any federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (ii) promoting, marketing, or recommending to another person any transaction or matter addressed herein.