In a defined contribution plan, what percentage of covered payroll is the company limit as per Section 415?

In a defined contribution plan, Section 415 of the Internal Revenue Code establishes limits on contributions made to these plans to ensure they remain within specified boundaries for tax advantages. The limit on annual additions, as defined in Section 415, is set at the lesser of 100% of the participant's compensation or a specific dollar amount, which is subject to inflation adjustments.

However, for contributions made by the employer, particularly in the case of profit-sharing plans, the limit is typically 25% of the covered payroll. This percentage encompasses all contributions made on behalf of an employee, including both employer and employee contributions, and is crucial for compliance with the tax code. Keeping employer contributions at or below this threshold ensures that the plans maintain their qualified status under IRS regulations.

Understanding these limits is vital for plan sponsors and participants, as exceeding them can lead to tax penalties and disqualification of the retirement plan, affecting the benefits employees expect to receive.