Insight
November 12, 2009
Deflation and the effect on benefit plan limits
By Brian Donohue, Senior Vice President, Aon Consulting
Most 2010 IRS benefit plan limits and Social Security benefits and thresholds remained
unchanged from 2009 despite a roughly 2% decrease in the CPI. In this article we look at the
implications of this unusual occurrence beyond 2010.
Social Security and many benefit plan limits are indexed to inflation, as measured from the
third quarter of one year to the next. In anticipation of a drop in the Consumer Price Index
(CPI) from 2008 to 2009, questions were stirring about how the various amounts would be
affected. When the official numbers confirmed a decline of roughly 2%, we soon learned, for
2010, Social Security benefits and most every benefit plan limit would remain unchanged.
But looking beyond 2010, what does this mean?
Inflation indexing
Let’s start with Social Security. Retiree benefits are adjusted based on the change the
Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which
dropped 2.1% from third quarter 2008 to third quarter 2009. But only increases, not
decreases are automatic. Thus, Social Security benefits will not be adjusted for inflation in
2010 (in contrast, benefits had risen 5.8% for 2009).
Looking ahead to 2011, this negative change in CPI lingers. Since 2009 CPI-W went down
while benefits remained unchanged for 2010, any change in benefits for 2011 will be based
on CPI-W for 2010 relative to 2008 (not 2009). Thus, it will take roughly a 2% inflation level
for this next year to break even. For example, if there is a 3% growth in CPI-W from third
quarter 2009 to third quarter 2010, Social Security benefits for 2011 will reflect an inflationadjustment of just the excess 1%.
A similar automatic adjustment basis is used for various IRS benefit plan limits, such as the
maximum 401(k) contribution, except CPI for All Urban Consumers (CPI-U) is used instead
of CPI-W. In addition, these limits have rounded thresholds that have to be crossed before a
change is realized. The chart below shows some key limits and the inflation needed over this
next year to generate a change, given the 1.6% drop in CPI-U over the last year.
Key benefit plan limitations
2009
2010
Next
threshold
$ 195,000
$ 195,000
$ 200,000
197,360
194,156
Inflation
needed to
increase
Defined benefit dollar limit [415(b)]
Rounded threshold
Unrounded (estimated for 2010)
November 2009
3.0%
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Insight
Deflation and the effect on benefit plan limits
Key benefit plan limitations
2009
Next
threshold
2010
Inflation
needed to
increase
Defined contribution dollar limit [415(c)]
Rounded threshold
49,000
49,000
Unrounded (estimated for 2010)
49,340
48,539
Rounded threshold
16,500
16,500
Unrounded (estimated for 2010)
16,707
16,436
Rounded threshold
5,500
5,500
Unrounded (estimated for 2010)
5,569
5,479
50,000
3.0%
17,000
3.4%
6,000
9.5%
250,000
3.0%
115,000
4.9%
401(k) deferral limit [402(g)]
Catch up contribution limit [414(v)]
Qualified plan compensation limit [401(a)(17)]
Rounded threshold
245,000
245,000
Unrounded (estimated for 2010)
246,700
242,695
Highly compensated employee threshold [414(q)]
Rounded threshold
110,000
110,000
Unrounded (estimated for 2010)
111,472
109,662
Wage indexing
Apart from the inflation-indexing discussed above, many elements of the Social Security
formula are adjusted for increases in the “national average wage” as calculated by the
Bureau of Labor Statistics (BLS). There is a two-year lag between changes in the “national
average wage” and adjustments to Social Security benefits, since the 2008 national average
wage ($41,334.97, a 2.3% increase over the 2007 figure of $40,405.48) only recently
became available. The 2.3% increase will be reflected in the “wage-indexed” components of
the Social Security benefit formula for 2010 (e.g., the “bend points”), increasing benefit
amounts for those reaching age 62, dying, or becoming disabled in 2010.
However, on the financing side, the Social Security taxable wage base is also indexed to the
national average wage, but includes an override of no increase in the event of no inflation
adjustment of Social Security benefits. So, that amount ($106,800 for 2009) will remain
unchanged in 2010. Looking ahead to 2011, as long as there is any inflation adjustment of
November 2009
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Insight
Deflation and the effect on benefit plan limits
Social Security benefits (recall, that means inflation will have to exceed 2%), then the full two
years of wage growth between 2007 and 2009 will increase the 2011 taxable wage base.
Finally, various Pension Benefit Guaranty Corporation (PBGC) amounts are also tied to
wage indexation, with some interesting results. On one hand, the PBGC maximum
guaranteed benefit remains at $4,500 per month for 2010 because it is directly linked to
changes in the Social Security taxable wage base. In contrast, the PBGC’s per-participant
flat-rate premium, $34 for 2009, will increase to $35 for 2010 because it is tied to increases
(not decreases) in national average wages. If national average wages were to decrease, the
premium rate would remain level until subsequent increases in average wages were
sufficient to warrant an increase in the premium rate.
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For more strategies on retirement programs, contact
Brian Donohue at 312.732.2164 or brian.donohue@aon.com.
November 2009
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