401k - highly compensated employee

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tj
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401k - highly compensated employee

Post by tj »

Evidently I am considered a "highly compensated employee" and can only contribute 5% more than the average non-highly compensated employees.

As such, I am getting a chunk of my contributions back. Why should I be penalized because co-workers do not want to defer as much income for retirement as I do?

Also, what about all the gains in my funds since then?
Sidney
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Post by Sidney »

That was the way the law was written to prevent senior management from creating special deals for themselves. Some companies create non-qualified plans that allow additional contributions by high income employees but if I am not mistaken, the penalty for that is that the company cannot deduct the expense associated with the plan and the plan is not protected in ways that a qualified plan is. For example, the deferrals in some (all?) NQ plans are general liabilities of the company and if the company goes bust they can stiff you. I am not sure where you would end up in the line of creditors with a NQ plan.

When I left my last employer, they had to disgorge the NQ portion of my savings plan in one distribution. I had no choice but to take the distribution and pay the tax. I don't know if this is required for NQ plans or just the way the plan was written.

There are many mysterious provisions in the tax code as they relate to retirement and deferred compensation plans and often, the only logic to it is "that is the way the law is written."
Last edited by Sidney on Thu Feb 24, 2011 5:38 pm, edited 1 time in total.
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livesoft
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Post by livesoft »

You should be penalized because you did not lobby your people to provide better 401(k) incentives to the rank-and-file employees. If the rank-and-file had contributed enough (or if the company just made contributions for them), then you would be able to max out.

It is really that simple. You can start your lobbying today before you go home.
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Topic Author
tj
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Post by tj »

Evidently the 401k company believes I am highly compensated (I'm not.) because I am related to the owner. It's annoying. I know safe harbor was an option to allow higher contributions, but then employer matches are vested right away and management did not want to do that.
marie17
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Post by marie17 »

I work for a large global firm (not family owned) and although this year I am not a highly-compensated employee, I am one small cost-of-living raise away from being one. I'd love to hear what you decide to do with your returned contributions - and if there are other tax shelter type ways to deal with this. For me, lowering my AGI is very important - and not being able to contribute the 401k max would be a huge tax blow.
livesoft
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Post by livesoft »

Don't file your 2010 tax return until you know how this affects that return. Otherwise you may need to file an amended return. You should get a 1099R next year for this as well. The problem is that the 1099R comes next year, but won't necessarily need to be reported on your 2011 tax return.

There are also a few HCE excess distribution questions like this each year on the forum. You may be the first this year which makes you responsible to answer all subsequent threads on the same subject. :)
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Atilla
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Post by Atilla »

I am most definitely not related to my employer. The government has "discrimination tests" applied to "highly compensated employees" that will limit the money put into a 401K. I'm limited to about 4.5% of gross.

The company controller tries to set my 401K deduction each year so I come close to breaking even. In the spring he has to take a couple-few hundred out of my 401K and give it back to me. No big deal.

He did tell me the amount I can contribute to our 401K would increase if there was better participation amongst the rest of the employees. My company owners do run a "tight ship" so there very little 401K matching by the company.

I have large (for me) and growing taxable investment accounts where the money goes instead. "Fairness" has it's costs. Whatever - it is what it is.

:wink:
bdpb
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Post by bdpb »

Under these rules is it still possible to contribute after tax to the 401k?
If so, could there also be an option to do an in-service withdrawal?
Then might this allow for rolling the after tax contributions to a Roth IRA?
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tj
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Post by tj »

livesoft wrote:Don't file your 2010 tax return until you know how this affects that return. Otherwise you may need to file an amended return. You should get a 1099R next year for this as well. The problem is that the 1099R comes next year, but won't necessarily need to be reported on your 2011 tax return.

There are also a few HCE excess distribution questions like this each year on the forum. You may be the first this year which makes you responsible to answer all subsequent threads on the same subject. :)
I already filed. I was under the impression this would be income for 2011. Ugh.
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rob
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Post by rob »

It's actually worse then you think... A number of years ago I got a big hit when the plan failed it's discrimination tests - a chunk of $ as a return taxed at short term gains, reduced contributions going forward, PITA tax forms and adjustments to prior years e.t.c. "Funny" thing was I was earning less then my spouse at the time but she was fine because different type of company with a different mix of contributors.

Yeah there are safe harbor plans but no employer I know will pick that option.

It's all nonsense but I doubt it will ever get "reformed".... and given how politics works - maybe that's a good thing :-/

Edit: Oh yeah... wait for the 1099-R to see what year it related to... It might be a 2010 issue that will cause you to amend your return :-/
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien
livesoft
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Post by livesoft »

No, don't wait for the 1099R. Figure out what needs to be done now. Some of the rules have changed in the past couple of years, so which year this income gets added to is not quite clear to me. It could be 2010 or it could be 2011. I think you need to figure this out soon.

Funny story related to this: I got caught with this along with our CEO a few years ago. He had already filed his income tax return, but I had not. He had to get his tax return amended by his accountant at a cost to him. It was shortly thereafter that I got put on the 401(k) committee. We have a safe harbor plan now with the company making contributions to our 401(k) even if you don't contribute. It gives us 100% participation.
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interplanetjanet
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Post by interplanetjanet »

rob wrote:Yeah there are safe harbor plans but no employer I know will pick that option.
Mind if I ask what field you're in? Every non-governmental/university employer I've worked at (except for an internet startup) since '97 has has a safe harbor feature.

Guess this shows how different things can be. Yes, I am kicking myself over and over and over again over not availing myself more of their retirement plans while I was there. So it goes.

-Janet
Gerbil Wheel
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Post by Gerbil Wheel »

The refunds are now taxable in the year paid, thanks to the Pension Protection Act.

Here is a link to an excellent write-up of this issue. A wee bit technical but shouldn't intimidate this bunch:

http://asppa.org/Document-Vault/PDFs/TA ... stpdf.aspx
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rob
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Post by rob »

interplanetjanet wrote:Mind if I ask what field you're in? Every non-governmental/university employer I've worked at (except for an internet startup) since '97 has has a safe harbor feature.
A long time IT consulting working for various consulting agents which tended to be small companies (along with a chunk of time without a 401K) and more recently a very large financial services company. None of those had safe harbor 401K plans..... I agree it's funny how individual experiences taint views of what is generally available.
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien
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tj
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Post by tj »

Gerbil Wheel wrote:The refunds are now taxable in the year paid, thanks to the Pension Protection Act.

Here is a link to an excellent write-up of this issue. A wee bit technical but shouldn't intimidate this bunch:

http://asppa.org/Document-Vault/PDFs/TA ... stpdf.aspx
So any refunds I receive in 2011 would be taxable in 2011? At least I don't have to re-file...
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interplanetjanet
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Post by interplanetjanet »

rob wrote:A long time IT consulting working for various consulting agents which tended to be small companies (along with a chunk of time without a 401K) and more recently a very large financial services company. None of those had safe harbor 401K plans..... I agree it's funny how individual experiences taint views of what is generally available.
That's funny, as I've worked in IT since the early '90s, though most of my W2 employment has been directly with companies rather than through a consulting house...and two years ago I started work with a very large Internet-based financial services company.

-Janet [spooooooky ;)]
xerty24
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Post by xerty24 »

bdpb wrote:Under these rules is it still possible to contribute after tax to the 401k?
If so, could there also be an option to do an in-service withdrawal?
Then might this allow for rolling the after tax contributions to a Roth IRA?
No, there are stricter testing rules for after tax contributions than there are for regular ones. It would be very very rare that a plan where HCEs were limited in their regular contributions would to allow them to contribute at all through after tax contributions.
JordanIB
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Post by JordanIB »

I've never heard of such limitations. People who earn above a certain level are limited to how much they can contribute to a 401K? What is the threshold? Is this universal?
grberry
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Post by grberry »

JordanIB wrote:I've never heard of such limitations. People who earn above a certain level are limited to how much they can contribute to a 401K? What is the threshold? Is this universal?
The dollar limit is defined by Section 414(q)(1)(B) of the tax code, and other related issues are elsewhere in 414(q). It does change with cost of living adjustments. For 2009, 2010, and 2011 the dollar limit is $110,000. This number is part of a definition of the term highly compensated employee (HCE), and in that sense it is universal. A person is a HCE if any of the following are true: 1) you earned that much this year and were in the top 20% of the company for earnings, 2) you earned that much last year and were then in the top 20% of the company for earnings, or 3) you own more than 5% of the employer.

If an employer has created a safe harbor 401(k) plan, they don't have to test whether or not there was "discrimination" in favor of the highly compensated employees. Otherwise the test as to whether the average contribution for HCEs is enough (around 2% 10 years ago) bigger than the average contribution of non-HCEs. I haven't seen recent data on how many companies have been failing the test. In 2001, before a couple law changes that may have helped, around 40% of companies had to either restrict or refund HCE contributions to pass the test. Failing the test and failing to refund excess contributions will kill the entire plan for everybody.

Thus, the effective contribution limit is determined by the contributions of the non-HCEs. This is an employer specific analysis, and changes for a given employer from year to year.

If refunds have to happen, they start with the HCE who contributed the most dollars, and lower them and as needed the next highest contributor, etc... until all HCEs have collectively little enough to meet the test. This article while dated, does a good job explaining it.
Last edited by grberry on Thu Feb 24, 2011 11:00 pm, edited 1 time in total.
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tj
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Post by tj »

JordanIB wrote:I've never heard of such limitations. People who earn above a certain level are limited to how much they can contribute to a 401K? What is the threshold? Is this universal?
From the linked article:

ADP = Average deferral percentage
NHCE = Non highly compensated Employee
HCE = Highly compensated Employee
NHCE’s ADP Maximum HCE Limit
0 to 2% 2 times the NHCE ADP
2% to 8% Add 2 to the NHCE ADP
>8% 1.25 times the NHCE ADP
The 5% owner rule also requires careful review of the ownership attribution rules for families and trusts. In effect, certain family members are deemed through their relationship to share in the ownership interests of the 5% owner. The family relationships taken into consideration when determining attribution of ownership include spouse, parent, child and grandchild. An adopted child is also taken into consideration; siblings, grandparents and in-laws are not included.
wts
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Post by wts »

Does it ever make sense for an HCE in a non-safe harbor plan to make massively excessive contributions knowing it will all come back as taxable income? Seems to me market returns will always be lower than tax rates so it wouldnt be a good idea.

I wonder because we only have a few HCE's and one of them is contributing well in excess of the others.

So he's probably excluded from the HCE limits but I know the others arent because they wait for the excess contrib check to show up before filing.


:undecided
Bharat
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Re: 401k - highly compensated employee

Post by Bharat »

Around 13K of my contribution as I fall in "Highly compensated employee" was returned from my 2011 contribution, and 10% of the money was kept for federal taxes. Now, I am doing my taxes, and wanted to check couple of things:

1) Turbo Tax: Show the returned money as "Wages and Salaries" OR " Retirement Plans and Social Security; 1099-R, IRAs, 401(k), early withdrawals"

2) I have not received 1099R form. Should I file for extension and get this cleared up?

3) Do I have to pay 10% penalty for the even if this is NOT a voluntary withdrawal?

Thank you for your help.
Everything that you own, owns piece of you.
Alan S.
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Re: 401k - highly compensated employee

Post by Alan S. »

You should have received a 1099R in January for a 2012 distribution, and at this point you should file an extension (unless you are totally sure of the amount and year distributed) and immediately call the plan administrator about your 1099R.

The amount distributed will be added to your line 7 wages in the year of the DISTRIBUTION (2012?) and is NOT subject to the 10% penalty.
Bharat
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Re: 401k - highly compensated employee

Post by Bharat »

Alan S. wrote:You should have received a 1099R in January for a 2012 distribution, and at this point you should file an extension (unless you are totally sure of the amount and year distributed) and immediately call the plan administrator about your 1099R.

The amount distributed will be added to your line 7 wages in the year of the DISTRIBUTION (2012?) and is NOT subject to the 10% penalty.
Thanks Alan, appreciate your inputs.
Everything that you own, owns piece of you.
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