Retirement-Planning Alert: How 2024 IRS Limits On Tax-Qualified Plans Affect Nonqualified Deferred Comp

Squirrel

Executives and highly compensated employees often have both equity comp and the opportunity to participate in a nonqualified deferred compensation (NQDC) plan. For many NQDC plan participants, it’s time again to make like an autumn squirrel and decide how much to store for the future. In November and December, they must decide how much of next year’s salary to defer.

Factors in this decision about nonqualified plans include the IRS limits that apply to qualified retirement plans. The IRS just set the qualified plan limits for 2024. That’s crucial info for employees and executives who can participate in company NQDC plans.

How The 2024 IRS Qualified Plan Limits Affect Nonqualified Deferrals

Generally, you defer income via nonqualified plans only when you know you will max out your yearly contributions to qualified plans. Therefore, the contribution limits set by the IRS on qualified plans, adjusted annually for inflation, are important for NQDC planning.

If you’ve already maxed out your qualified plan contributions for 2023, you will probably do the same in 2024, so you will need NQDC plans to defer any salary and bonus increases you expect in 2024. Your motivation to defer may be boosted further if you believe tax increases are on the way and will affect you.

2024 IRS Contribution Limits For Qualified Plans

The IRS changes in limits for 2024 are much smaller than the increases for 2023 because these adjustments are based on the inflation rate, which has moderated. Here are the key annual contribution limits on qualified retirement plans for 2024, along with the 2023 limits for comparison:

Contribution type/limit 2023 2024
Compensation limit in qualified deferral and match calculation $330,000 $345,000
Elective compensation deferrals, such as 401(k) and 403(b) $22,500 $23,000
Catchup contribution for people aged 50 or older $7,500 $7,500
Total defined contribution limit (employee and employer contributions) $66,000 +
catchup contribution
$69,000 +
catchup contribution
Defined benefit plan payout limit $265,000 $275,000
Income threshold defining key employees for top-heavy plans and six-month delay on payout upon separation $215,000 $220,000
Income threshold defining highly compensated employees for nondiscrimination testing; this also applies to income point where companies can exclude employees from a tax-qualified ESPP $150,000 $155,000

Qualified Versus Nonqualified Retirement Plans

The yearly contribution limits for qualified retirement plans are a big reason why companies offer nonqualified plans: to let executives and other highly compensated employees save extra money for retirement with an elective nonqualified plan or an excess 401(k) plan. The deferred income is “nonqualified” because it does not fit the rules in the tax code that allow tax-qualified plans, such as 401(k) and 403(b) plans.

Nonqualified deferred comp allows you to put away amounts beyond the permissible contribution amounts of standard qualified retirement plans. For retirement planning, it can therefore bridge the considerable gap that arises between the amount of income that you will actually need in retirement and the amount of income that can be provided via your 401(k) plans and Social Security.

Nonqualified Deferrals Have Complex Rules

Nonqualified deferred compensation plans and their participants must follow the complex rules under Section 409A of the US tax code. These rules govern your deferral and distribution elections. The amounts that you defer can only be informally funded by your company, and they are at risk should the company enter bankruptcy proceedings.

The website myNQDC.com is a comprehensive resource on NQDC plans, including the basics, the deferral/distribution process, the risks, and the related financial and tax planning.

Social Security Wage Cap Also Rises In 2024

Set by the Social Security Administration, the Social Security wage cap will rise to $168,600 in 2024, up from $160,200 in 2023.

With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding is $9,932.40 in 2023 and will rise to $10,453.20 in 2024.

Social Security tax (up to the yearly limit) and Medicare tax (uncapped) are withheld at the time of deferral, as shown by an FAQ at myNQDC with an annotated diagram of Form W-2 showing where these amounts are included.

Further Resources

For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ at myNQDC.com. See also the website’s FAQ on the top NQDC-related issues in year-end planning.


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2023 Tax Planning: The 3 Numbers All Employees Should Know

tax zen

Before tax-return season sets in, putting your focus on your 2022 income, this is a good time to meditate on your tax planning for 2023. That includes the federal tax-related numbers for 2023 that are crucial for all employees, their paychecks, and their planning.

The IRS and the Social Security Administration annually adjust for inflation a myriad of key numbers in federal tax-law provisions—and in 2023, given the economic cycle we're in, some of these changes are bigger than in past years. However, it can be difficult to spot the adjustments that matter to you.

Some apply only to very high-net-worth executives and other super-wealthy people. For example, there's the federal estate-tax exemption (in 2023, $12.92 million for single taxpayers and $25.84 million for married joint filers). Others of interest mainly to administrators of corporate benefit plans and other experts (like us here at myStockOptions) who keep track of this stuff. For example, the income definition of “highly compensated employee,” which affects eligibility for employee stock purchase plans (ESPPs) and 401(k) plan non-discrimination testing, is $150,000 in 2023.

This article clears away all that to focus your mind on the essential points for you. Below are the top three sets of tax figures in 2023 that all employees should know. They relate to compensation from work: paycheck withholding, the potential need for estimated taxes, and your retirement savings.

1. The Social Security Wage Base

The Social Security tax (at a rate of 6.2%) applies to wages up to a maximum amount per year that is set annually by the Social Security Administration. Income above that threshold is not subject to the Social Security tax. (By contrast, the Medicare tax is uncapped, with a rate of either 1.45% or 2.35%, depending on your income level.)

In 2023, the Social Security wage cap is $160,200, up from $147,000 in 2022. This means the maximum possible Social Security withholding in 2023 is $9,932.40. Once your income is over the wage cap and you’ve maxed out the withholding, you’ll see 6.2% more in your paycheck!

2. Your Income-Tax Bracket And Withholding

If you’re an employee, your company withholds taxes from your paycheck according to the information on your Form W-4. Showing the federal income-tax brackets and their rates, the table below can help you understand how an additional amount of compensation would be taxed at your marginal tax rate, i.e. the percent of tax you pay for an additional dollar of income in your current tax bracket. That number tells you whether the withholding as indicated on your W-4 will cover the total tax you will owe for 2023. To avoid “penalizing” additional income in your mind, be sure you know your effective or average tax rate.

Need To Pay Estimated Taxes?

Additional compensation received, such as a cash bonus or income from a nonqualified stock option exercise or vesting of restricted stock units, is considered supplemental wage income. For federal income-tax withholding, most companies do not use your W-4 rate for this income. Instead, they apply the IRS flat rate of 22% for supplemental income (the rate is 37% for yearly supplemental income in excess of $1 million).

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As shown by the table above, once you know your marginal tax-bracket rate, you may find the withholding rate of 22% does not cover all of the taxes that you will owe on supplemental wage income. In that case, you must either put extra money aside for the 2023 tax return you will file in 2024, pay estimated taxes during 2023, or adjust your W-4 for your salary withholding as soon as possible to cover the shortfall. Speak with a qualified tax professional, such as a CPA or Enrolled Agent, when you’re uncertain about the best approach to take.

If estimated taxes are the route you choose, know that due dates for quarterly estimated tax payments in the 2023 tax year are April 18, June 15, and September 15 of 2023 and January 16 of 2024. (The IRS routinely postpones these due dates for taxpayers in areas of the United States affected by natural disasters. See the IRS website section Tax Relief In Disaster Situations.)

3. Your Contribution Limit For Qualified Retirement Plans

In 2023, you can elect to defer up to $22,500 from your paychecks into qualified retirement plans, such as your 401(k). That annual limit increased from $20,500 in 2022.

The total ceiling for deferrals to defined contribution retirement plans, including any extra part contributed by your employer, rose to $66,000 in 2023, a $5,000 increase over last year’s amount. If you are 50 or older, you can contribute an additional $7,500 per year, a limit that also went up in 2023.

The amount of compensation income that can be considered in the calculation for qualified deferrals grew to $330,000 in 2023. Check with your company’s 401(k) plan administrator for the process of making changes in your compensation deferral election.

Want To Defer More Income?

Look into whether your company has a nonqualified deferred compensation plan, sometimes called an excess 401(k) plan. For more on these plans, see the website myNQDC.com.

Inflation Adjustments For Health Savings Accounts (HSAs)

While not all employees have them, health savings accounts (HSAs) are also getting an increase in their pre-tax contribution limits for 2023 in response to inflation. HSAs are available only for high-deductible health plans.

The IRS has raised the yearly contribution limit for HSA self-only coverage to $3,850, up by $200 from last year, and for family coverage it is now $7,750, up from $7,300 in 2022. The limit for HSA catch-up contributions, available for people ages 55 or older, remains $1,000. With more companies setting up pre-tax payroll deductions for HSAs and matching employee contributions, these increases could be significant for many people as the cost of health care continues its relentless rise.

IRS Resources

Here are resources with more details on the many adjusted 2023 tax numbers:


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Alert: NQDC Participants Affected By 2021 Limits For Qualified Retirement Plans

We now bring you important news for squirreling away retirement savings from our sibling website, myNQDC.com.

In November and December, many executives and key employees eligible to participate in nonqualified deferred compensation (NQDC) plans must decide how much of next year's salary to defer. Factors in this decision about nonqualified plans include the IRS limits that apply to qualified retirement plans (and this year also the outlook for future tax rates after the 2020 election). The IRS just set the qualified plan limits for 2021.

The contribution limits of qualified plans are the major reason for the existence of nonqualified plans: to allow executives and key employees to save additional amounts for retirement with an elective nonqualified plan or an excess 401(k) plan.

The changes in limits from 2020 to 2021 are slight. If you've already maxed out your qualified plan contributions for 2020, you will probably do the same in 2021, so you will need NQDC plans to defer any salary and bonus increases you expect in 2021. Also, depending on the election results, there may be higher tax rates next year, increasing the need to defer income.

Contribution type/limit 2020 2021
Compensation allowed in qualified deferral and match calculation $285,000 $290,000
Elective compensation deferrals $19,500 $19,500
Catchup contributions for people aged 50 or older $6,500 $6,500
Total defined contribution limits (employee and employer contributions) $57,000 +
catchup contribution
$58,000 +
catchup contribution
Defined benefit plan payout limits $230,000 $230,000
Income threshold defining key employees for the purposes of top-heavy plans and the six-month delay on payout upon separation $185,000 $185,000
Income threshold defining highly compensated employees for the purposes of nondiscrimination testing; this also applies to the income point where companies can exclude employees from a tax-qualified ESPP $130,000 $130,000

Set by the Social Security Administration, the Social Security wage cap will rise in 2021 to $142,800, a slight increase from $137,700 in 2020. With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding is $8,537.40 in 2020 and will rise to $8,853.60 in 2021. Social Security tax (up to the yearly limit) and Medicare tax (uncapped) are withheld at the time of deferral, as shown by an FAQ at myNQDC with an annotated diagram of Form W-2 showing where these amounts are included.

For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ at myNQDC. See also our FAQ on the top NQDC-related year-end-planning issues.

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The Top 3 Tax Numbers In 2020 That Employees With Equity Comp Should Know

tax planningTax-return season looms, meaning you will soon have to focus on reporting your 2019 income, including compensation from stock plans or gains from stock sales. However, before that, remember your basic tax planning for 2020.

At the start of each year, many key numbers in tax-law provisions are adjusted for inflation. It can be hard to spot those that matter to you. Below are the top three sets of tax figures that highly compensated employees should know: the Social Security income ceiling, your marginal tax rate, and how much you can put into your 401(k) plan.

1. Social Security Wage Base

Social Security tax (6.2%) applies to wages up to a maximum amount per year set annually by the Social Security Administration. Income above that threshold is not subject to Social Security tax (by contrast, Medicare tax is uncapped, with a rate of either 1.45% or 2.35%, depending on your income level). In 2020, the Social Security wage cap is $137,700, up slightly from $132,900 in 2019. This means the maximum possible Social Security withholding in 2020 is $8,537.40. Once your income is over that amount, you'll see 6.2% more in your paycheck or in the income you get from stock compensation, such as an NQSO exercise or RSU vesting.

2. Income-Tax Brackets And Withholding

The table below can help you understand how an additional amount of compensation would be taxed at your marginal tax rate (i.e. the percent of tax you pay for an additional dollar of income in your current tax bracket). This number tells you whether the taxes withheld according to your information on the newly revised Form W-4 will cover the total tax you will owe for 2020. To avoid "penalizing" additional income in your mind, be sure you know your effective or average tax rate.

RATE TAXABLE INCOME (SINGLE) TAXABLE INCOME (JOINT)
10% $0 to $9,875 $0 to $19,750
12% $9,876 to $40,125 $19,751 to $80,250
22% $40,126 to $85,525 $80,251 to $171,050
24% $85,526 to $163,300 $171,051 to $326,600
32% $163,301 to $207,350 $326,601 to $414,700
35% $207,351 to $518,400 $414,701 to $622,050
37% $518,401 or more $622,051 or more

Need To Pay Estimated Taxes?

Additional compensation received, such as a cash bonus or income from a nonqualified stock option exercise or vesting of restricted stock units, is considered supplemental wage income. For federal income-tax withholding, most companies do not use your W-4 rate. Instead, they apply the IRS flat rate of 22% for supplemental income (the rate is 37% for yearly supplemental income in excess of $1 million).

As shown by the table above, once you know your marginal tax-bracket rate, you may find the withholding rate of 22% may not cover all of the taxes that you will owe on supplemental wage income. In that case, you must either put extra money aside for the tax return you file in 2021, pay estimated taxes during 2020, or adjust your W-4 for your salary withholding as soon as possible to cover the shortfall.

3. Qualified Retirement Plans

In 2020, you can elect to defer up to $19,500 from your pay into qualified retirement plans, such as your 401(k). This is a $500 increase over the 2019 limit.

The total ceiling for deferrals to defined contribution retirement plans (including any additional part contributed from your employer) rose to $57,000 in 2020, a $1,000 increase. Both of these limits are $6,500 higher if you are 50 or older. The amount of compensation income that can be considered in the calculation for qualified deferrals is $285,000 in 2020. Check with your company’s 401(k) plan administrator for the process of making changes in your compensation deferral election.

Want to Defer More Income?

Look into whether your company has a nonqualified deferred compensation plan, sometimes called an excess 401(k) plan or other name. For more on these plans, see our sibling website myNQDC.com.

IRS Resources

Here are resources with more details on the many adjusted 2020 tax numbers:


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Adjustments To Qualified Retirement Plan Limits For 2013: Impact On Nonqualified Deferred Compensation

For people who use myNQDC.com, our sister website, news has emerged that will be important to both professionals and participants in company retirement plans, such as 401(k) and nonqualified deferred compensation (NQDC) plans. Every fall, usually in October, the IRS announces limits that will apply in the following year to contributions made under qualified retirement plans. These numbers are adjusted annually for changes in the cost-of-living index. The contribution limits of qualified plans form the major reason for the existence of nonqualified plans: to allow executives and key employees to save additional amounts for retirement with an elective nonqualified plan or an excess 401(k) plan. Earlier this month, the IRS announced the adjustments that apply in 2013. Around the same time, the Social Security Administration also announced an increase in the wage based used for calculating the Social Security part of FICA tax: in 2013, the wage cap will be $113,700 (up from $110,100 in 2012).

Qualified Plan Contributions: Annual Limits That Affect NQ Deferred Comp Plans

Contribution type/limit

2013

2012

Compensation allowed in qualified deferral and match calculation

$255,000

$250,000

Elective compensation deferrals

$17,500

$17,000

Catchup contributions for people aged 50 or older

$5,500

$5,500

Total defined contribution limits (employee and employer contributions)

$51,000 + catchup contribution

$50,000 + catchup contribution

Defined benefit plan payout limits

$205,000

$200,000

Income threshold defining key employees for the purposes of top-heavy plans and the six-month delay on payout upon separation

$165,000

$165,000

Income threshold defining highly compensated employees for the purposes of nondiscrimination testing

$115,000

$115,000

For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ on myNQDC.com.


Good News: Contribution Limits For 401(k)s And Other Qualified Retirement Plans Will Rise In 2012 Along With Social Security Benefits

As we noted earlier this week, Social Security benefits will increase by 3.6% in 2012, with commensurate growth in the yearly wage base for Social Security tax (from the current $106,800 to $110,100 in 2012). On October 20, the IRS announced other cost-of-living increases in the amounts that can be contributed to qualified retirement plans, such as 401(k) plans. For example, the elective deferral contribution limit for employees who participate in 401(k)s, 403(b)s, most 457 plans, and the federal government's Thrift Savings Plan will grow from $16,500 to $17,000 in 2012. However, the yearly ceiling on additional catchup contributions for people aged 50 years or more will stay at $5,500.

The annual compensation limit that can be used for calculating the contributions under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) will rise from $245,000 to $250,000. The ceiling for defined contribution plans under Section 415(c)(1)(A) is also going up in 2012, from $49,000 to $50,000. Anyone wanting to contribute more will have to use a nonqualified deferred compensation plan. One of the benefits of a nonqualified plan is that you can contribute much higher amounts toward retirement than you can under qualified plans, such as a 401(k).


Cost-Of-Living Increase Will Raise Social Security Wage Base, With Impacts On Stock Comp

The recently announced 3.6% cost-of-living increase in Social Security benefits scheduled for next year means a commensurate increase in the wage base used to calculate the tax. The yearly wage base, which has been $106,800 since 2009, will rise to $110,100 in 2012. Amounts of income above the threshold of the wage base are not subject to Social Security tax but are still subject to Medicare (which is uncapped).

If the Social Security tax returns in 2012 to its usual rate of 6.2%, after the special reduction to 4.2% in 2011, then this raising of the yearly wage base will be a meaningful tax increase of up to $2,341. However, the 4.2% rate may still be extended through 2012. (President Obama's proposal to cut the rate to 3.1%, half the regular rate of 6.2%, was defeated in the Senate last week along with the rest of his jobs bill.)

The growth of the Social Security wage base will affect the withholding for salary, bonuses, deferred compensation, and certain types of equity compensation, such as nonqualified stock options and restricted stock. The "Withholding" sections of the Tax Center at myStockOptions.com clearly explain the withholding rules for each type of equity compensation plus employee stock purchase plans. On our other website, myNQDC.com, the withholding rules for nonqualified deferred compensation are covered in the section Taxes: Reporting.


Using Stock Comp To Help Grow IRA Savings

Our latest article series, in two parts, takes on one of the hottest topics in personal finance today: Strategic Planning With Roth IRAs And Stock Compensation by Sue Stevens, a noted wealth advisor and the former director of financial planning at Morningstar. Anyone can now convert a traditional IRA to a Roth IRA, and for a conversion in 2010 you can split the taxes due over 2011 and 2012 (50% each year). Part 1 explains the rules of converting traditional IRAs to Roths, discusses the role that stock compensation can play, and examines the related planning issues. Part 2 illustrates these points with a detailed case study. These articles superbly enhance our extensive content on the use of stock compensation in retirement planning.