Payroll In Practice: 12.23.2024

Question: What are the contribution limits for defined benefit and defined contribution retirement plans for 2024 and 2025?

Answer: Each year the Internal Revenue Service announces cost-of-living adjustments to limitations on benefits and contributions for qualified retirement plans. The 2025 limitation amounts were released in Notice 2024-80 on Nov. 1, 2024. These limits vary according to the types of plans.

The two types of plans are defined benefit plans and defined contribution plans.

A defined benefit plan provides a specific benefit to the participant upon retirement. This might be a defined amount per period, such as a month or year, or a percentage of compensation paid during employment. The benefit amount is usually based on factors like the employee’s earnings, age, and years of service.Employer contributions are not taxable to the employee when they are made.

Contributions to a defined benefit plan are based on the amount of funding required to provide the benefits to plan participants. Actuarial assumptions and computations are used to estimate the benefits that will be paid from the plan in the current year and future years. That projection determines the contribution amount necessary to fund the projected benefit payments.

Annual contributions for an employee are limited to the amount needed to provide the projected future annual benefit for that employee. Generally, the annual benefit for a participant under a defined benefit plan cannot exceed the lesser of either 100% of the participant’s average compensation for their highest-earning three consecutive calendar years or an amount defined by the IRS, which is $275,000 for 2024 and increased to $280,000 for 2025.

Defined contribution plans provide individual accounts for each plan participant. Benefits are based primarily on employee and employer contributions to the account as well as any income, expenses, gains, losses, and forfeitures allocated from other accounts. A defined contribution plan can be either a profit-sharing plan or a money-purchase pension plan.

A profit-sharing plan allows for discretionary employer contributions. Employer contributions to a money purchase plan are fixed by the plan. For example, a money purchase plan might require employer contributions equal to 10% of a participant’s annual compensation. In general, the annual addition for a participant under defined contribution plan cannot exceed the lesser of 100% of the participant’s compensation or an amount determined by the IRS, which is $69,000 for 2024 and $70,000 for 2025.

The limit generally applies to additions to an individual’s account, including any coming from employer matching and profit-sharing contributions, allocated forfeitures, employee contributions, and employee elective deferrals.

The employer’s income tax deduction for contributions is limited to 25% of the compensation paid or accrued during the year to eligible employees participating in the plan. Elective deferrals are included in employee compensation to determine compliance with this limit. The maximum compensation that the employer may take into account for each employee is $345,000 for 2024 and $350,000 for 2025.

Special employee salary deferral contribution limits apply to 401(k), 403(b), SIMPLE, and SARSEP plans, regardless of the number of plans in which the employee participates or whether there is more than one employer. The limit on employee deferrals is the lesser of either 100% of the participant’s compensation (applied separately to each employer) or an amount defined by the IRS, which is $23,000 for 2024 and $23,500 for 2025.

The limitation for 401(k), 403(b), SIMPLE, and SARSEP plans is increased by any catch-up contributions such as the $7,500 catch-up contribution allowed for individuals age 50 or over. Starting in 2025, a new catch-up contribution limit of $11,250 is available for employees reaching ages 60 to 63 in 2025.

Individual plans may specify lower contribution limits. For instance, if an employee participates in both the employer’s 401(k) and 403(b) plans, both plans permit the maximum $ 23,000 contribution for 2024. However the 403(b) plan does not allow age-50 catch-up contributions. Employee deferrals cannot exceed either the individual limit plus the $7,500 catch-up amount. Between the two plans the employee can still contribute a total of $30,500 ($23,000 + $7,500) in pretax and designated Roth contributions but could not contribute more than $23,000 to the 403(b) plan.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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