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New compensation limit for qualified retirement plans.

Small business

The Omnibus Budget Reconciliation Act of 1993 (OBRA) lowered the maximum employee compensation used to calculate a qualified retirement plan contribution. Effective for plan years beginning after 1993, the limit on eligible compensation drops from $235,840 to $150,000.

For small businesses with 15% defined-contribution plans, the old earnings limit allowed owners' contributions to reach the $30,000 maximum in the law. Applying the 15% rate to the new earnings limit produces only a $22,500 maximum contribution.

Business owners whose maximum contributions are reduced in this way may wish to adopt a money-purchase pension plan, which allows a higher percentage contribution (up to 25%). If other, younger employee participants are involved, an age-weighted plan may benefit the owner.

Observation: Although the new earnings limit does not affect 401(k) plans directly, it may have an adverse effect on discrimination testing. Highly compensated participants will have a higher actual deferral percentage (the percentage of earnings that are deferred), since their elective contributions will be placed over the smaller denominator of $150,000.

As a result incentives may have to be increased or minimum contributions may be required for the lower paid group. Alternatively, 401 (k) plans may even be eliminated if they're deemed too costly by employers. --Andrew R. Biebl, CPA, Biebl, Ranweiler & Co., New Ulm, Minnesota
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Title Annotation:effect on small businesses
Author:Biebl, Andrew R.
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Dec 1, 1993
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