401k excess contribution/highly compensated employee

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Open Wide
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401k excess contribution/highly compensated employee

Postby Open Wide » Thu May 18, 2017 9:00 am

I just found out that I will be getting around $6k of my 2016 401k contributions returned to me due to "excess contributions". Apparently I am considered a "highly compensated employee" and even though I maxed my plan at $18k last year (no employer match), because other employees didn't participate or didn't contribute as much, that affects how much I can contribute.

If I understand correctly, there is a formula that calculates this and I'm picturing it being done by someone like Matt Damon in Good Will Hunting on a chalkboard in a dark room. I still don't quite understand how maxing my plan affects other employees, but apparently this levels the playing field somehow, even though it only feels like it's punishing the HCE's.

So, my question is what to do with the returned $6k... Wife and I currently max both 401k's, HSA's, and contribute to 2 y/o son's 529. $30k in emergency fund. Second son due in late August. I guess my options are:

1) Leaning towards putting it all in Vanguard Index Fund so that I qualify for Admiral Shares and prepare for the tax payment next April

2) Apply it to our student loans @ 3.375%; $245k balance that we plan to pay off in the next 2.5 years.

3) Keep it in our checking account for extra cash flow with baby #2 on the way; Peace of mind.

4) Apply to mortgage @ 4%; $260k balance

What do you think Bogleheads? We're leaning towards putting it in our after tax account so that we qualify for Admiral Shares and because we are a little behind on retirement accounts due to paying aggressively on student loans.

Thanks for your thoughts on this!

Lindrobe
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Re: 401k excess contribution/highly compensated employee

Postby Lindrobe » Thu May 18, 2017 9:14 am

You didn't mention if you have Roth accounts. Could be another possibility for you. At my husband's prior job, he was an HCE and when excess contributions were returned, we just dumped it into a taxable account because we were already maxing backdoor Roths. The whole HCE problem was just one of a few reasons that he moved on to greener pastures.

Open Wide
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Re: 401k excess contribution/highly compensated employee

Postby Open Wide » Thu May 18, 2017 9:29 am

Sorry... yes we both do a $5500 Backdoor Roth IRA each year.

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EATaxGuy
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Re: 401k excess contribution/highly compensated employee

Postby EATaxGuy » Thu May 18, 2017 10:16 am

Open Wide wrote:even though it only feels like it's punishing the HCE's.

It is. The intent is to encourage the company offer a less crappy plan so that more non-HCEs will participate. Unfortunately, many companies seem to be unconcerned with being told their plan is crappy.
You may have been handed a cactus, but sitting on it is up to you.

Open Wide
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Re: 401k excess contribution/highly compensated employee

Postby Open Wide » Thu May 18, 2017 10:36 am

EATaxGuy wrote:
Open Wide wrote:even though it only feels like it's punishing the HCE's.

It is. The intent is to encourage the company offer a less crappy plan so that more non-HCEs will participate. Unfortunately, many companies seem to be unconcerned with being told their plan is crappy.


This may be a stupid question, but what makes one plan better or worse than another? As far as I know we don't have a choice since our 401k is run through our payroll company (ADP Total Source). I don't see my employer doing a match any time soon, but should we be looking for a different company, better expense ratios, and/or better variety of investment choices? I have all my 401k money parked in a Voya Target Retirement Fund at the moment. Sounds like I'm probably screwed with most plans if the 2 HCE's max and everyone else doesn't/barely participates? We're only an office of about 20 employees, so maybe that plays a factor as well.

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EATaxGuy
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Re: 401k excess contribution/highly compensated employee

Postby EATaxGuy » Thu May 18, 2017 10:44 am

Open Wide wrote:This may be a stupid question, but what makes one plan better or worse than another? As far as I know we don't have a choice since our 401k is run through our payroll company (ADP Total Source). I don't see my employer doing a match any time soon, but should we be looking for a different company, better expense ratios, and/or better variety of investment choices? I have all my 401k money parked in a Voya Target Retirement Fund at the moment. Sounds like I'm probably screwed with most plans if the 2 HCE's max and everyone else doesn't/barely participates? We're only an office of about 20 employees, so maybe that plays a factor as well.

What the DoL is trying to engineer is an environment where HCE's do not derive greater benefits from the retirement plan than the non-HCEs. Without a match the primary benefit is the tax deduction, which the HCEs get at a higher top marginal rate than the non-HCEs.

There are Safe Harbor rules for retirement plans. Plans that conform to the Safe Harbor standard do not undergo non-discrimination testing. You might want to inquire about one of those.
You may have been handed a cactus, but sitting on it is up to you.

Open Wide
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Re: 401k excess contribution/highly compensated employee

Postby Open Wide » Thu May 18, 2017 10:46 am

EATaxGuy wrote:
Open Wide wrote:This may be a stupid question, but what makes one plan better or worse than another? As far as I know we don't have a choice since our 401k is run through our payroll company (ADP Total Source). I don't see my employer doing a match any time soon, but should we be looking for a different company, better expense ratios, and/or better variety of investment choices? I have all my 401k money parked in a Voya Target Retirement Fund at the moment. Sounds like I'm probably screwed with most plans if the 2 HCE's max and everyone else doesn't/barely participates? We're only an office of about 20 employees, so maybe that plays a factor as well.

What the DoL is trying to engineer is an environment where HCE's do not derive greater benefits from the retirement plan than the non-HCEs. Without a match the primary benefit is the tax deduction, which the HCEs get at a higher top marginal rate than the non-HCEs.

There are Safe Harbor rules for retirement plans. Plans that conform to the Safe Harbor standard do not undergo non-discrimination testing. You might want to inquire about one of those.


Makes sense! Thanks!

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flamesabers
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Re: 401k excess contribution/highly compensated employee

Postby flamesabers » Thu May 18, 2017 10:53 am

I would suggesting using the $6k towards your student loans.

Open Wide wrote:
EATaxGuy wrote:
Open Wide wrote:even though it only feels like it's punishing the HCE's.

It is. The intent is to encourage the company offer a less crappy plan so that more non-HCEs will participate. Unfortunately, many companies seem to be unconcerned with being told their plan is crappy.


This may be a stupid question, but what makes one plan better or worse than another? As far as I know we don't have a choice since our 401k is run through our payroll company (ADP Total Source). I don't see my employer doing a match any time soon, but should we be looking for a different company, better expense ratios, and/or better variety of investment choices? I have all my 401k money parked in a Voya Target Retirement Fund at the moment. Sounds like I'm probably screwed with most plans if the 2 HCE's max and everyone else doesn't/barely participates? We're only an office of about 20 employees, so maybe that plays a factor as well.


I don't think the 401k rules distinguishes between a good or bad plan. Hypothetically your company could have the best 401k plan ever, but you would still be subject to the HCE rules if only a small number of the non-HCEs wanted to save for retirement.

Instead, I see the rules as a safeguard against flagrant abuses of the 401k plan. To use an extreme example, let's say all of the non-HCEs in a company are eligible to contribute to the company's 401k, but they all make minimum wage. On paper the company's 401k plan is a benefit accessible to all employees. In practice though, who's going to be contributing to a 401k while making minimum wage? In this situation, it's clear the HCEs get a benefit from the company's 401k, but the non-HCEs don't because of their low wages.

wolf359
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Re: 401k excess contribution/highly compensated employee

Postby wolf359 » Thu May 18, 2017 10:56 am

EATaxGuy wrote:
Open Wide wrote:even though it only feels like it's punishing the HCE's.

It is. The intent is to encourage the company offer a less crappy plan so that more non-HCEs will participate. Unfortunately, many companies seem to be unconcerned with being told their plan is crappy.

The HCEs usually include management and/or the owner. The idea is that the primary benefits of the plan should not only go to the owner or the highest income people in the company, but rather, benefit everyone.

I've hit the HCE/excess contribution issue twice in my career, and resolved it both times. I talked to my HR rep to find out what test the plan was failing. At one company, we were close to the participation threshold. I talked to my fellow employees and encouraged them to participate. At a second company, we were nowhere close. In that case, I spoke to the President of the company. He was frustrated that he couldn't contribute, either. It turns out he was willing to set up a safe harbor plan. These days another option is auto-enrollment, where employees have the option to opt out.

YMMV. I could do this because these were both small companies.

ERISA Stone
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Re: 401k excess contribution/highly compensated employee

Postby ERISA Stone » Thu May 18, 2017 11:08 am

EATaxGuy wrote:
Open Wide wrote:even though it only feels like it's punishing the HCE's.

It is. The intent is to encourage the company offer a less crappy plan so that more non-HCEs will participate. Unfortunately, many companies seem to be unconcerned with being told their plan is crappy.


If you didn't have nondiscrimination testing in place, there are PLENTY of employers who wouldn't even tell their employEEs that a retirement plan exists. I've had them as clients.

lazydavid
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Re: 401k excess contribution/highly compensated employee

Postby lazydavid » Thu May 18, 2017 12:54 pm

EATaxGuy wrote:
Open Wide wrote:even though it only feels like it's punishing the HCE's.

It is. The intent is to encourage the company offer a less crappy plan so that more non-HCEs will participate. Unfortunately, many companies seem to be unconcerned with being told their plan is crappy.


Even non-crappy plans get saddled with this nonsense. Ours is decidedly decent:

-Pretty good selection of funds, many of them high-quality and extremely low-cost: 6bp for international index, 4bp for bonds, 3.5bp for total market or S&P 500
-Contribution available by the 2nd paycheck (delay just to get the account created)
50% match on up to 8% of salary, begins after first anniversary
-All contributions (employee or match) are 100% vested on date of deposit

And the overwhelming majority of employees participate. Still, anyone with more than $120k in 401k-eligible wages (salary + bonus, but not RSU vestments) is capped at 10% as an HCE. Which means most employees can max out their contribution UNLESS they make between $120-180k.

The TRULY highly-compensated employees, in addition to being able to max out their 401k (because they make more than $180k), also have a deferred-compensation plan, with similar investment choices. So it's pretty much only folks in the manager and sr. manager bands and some higher-end individual contributors who are impacted.

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EATaxGuy
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Re: 401k excess contribution/highly compensated employee

Postby EATaxGuy » Thu May 18, 2017 1:05 pm

lazydavid wrote:Even non-crappy plans get saddled with this nonsense. Ours is decidedly decent:

-Pretty good selection of funds, many of them high-quality and extremely low-cost: 6bp for international index, 4bp for bonds, 3.5bp for total market or S&P 500
-Contribution available by the 2nd paycheck (delay just to get the account created)
50% match on up to 8% of salary, begins after first anniversary
-All contributions (employee or match) are 100% vested on date of deposit

What is it lacking to qualify for Safe Harbor?
You may have been handed a cactus, but sitting on it is up to you.

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celia
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Re: 401k excess contribution/highly compensated employee

Postby celia » Thu May 18, 2017 1:23 pm

EATaxGuy wrote:What is it lacking to qualify for Safe Harbor?

The most straight-forward method is for the employer to contribute. They can contribute for everyone or do some kind of match for those who participate. I don't know the details.

lazydavid
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Re: 401k excess contribution/highly compensated employee

Postby lazydavid » Thu May 18, 2017 1:54 pm

EATaxGuy wrote:
lazydavid wrote:Even non-crappy plans get saddled with this nonsense. Ours is decidedly decent:

-Pretty good selection of funds, many of them high-quality and extremely low-cost: 6bp for international index, 4bp for bonds, 3.5bp for total market or S&P 500
-Contribution available by the 2nd paycheck (delay just to get the account created)
50% match on up to 8% of salary, begins after first anniversary
-All contributions (employee or match) are 100% vested on date of deposit

What is it lacking to qualify for Safe Harbor?


The match would have to be 100% on the first 4% instead of 50% on the first 8%. The results are effectively the same, since the 10% cap on HCE contributions means that the average non-HCE contribution is 8%. Therefore the "average" employee is already getting a 4% match. So our plan effectively and successfully encourages non-HCEs to take more advantage of the 401k than an equivalent safe harbor plan would (the average employee contribution would be a lot closer to 4% than 8% if we met the guidelines), and the HCEs get punished for that.

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EATaxGuy
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Re: 401k excess contribution/highly compensated employee

Postby EATaxGuy » Thu May 18, 2017 2:13 pm

lazydavid wrote:The match would have to be 100% on the first 4% instead of 50% on the first 8%. The results are effectively the same, since the 10% cap on HCE contributions means that the average non-HCE contribution is 8%.

UGH! :oops:
You may have been handed a cactus, but sitting on it is up to you.

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Thrifty Femme
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Re: 401k excess contribution/highly compensated employee

Postby Thrifty Femme » Thu May 18, 2017 7:38 pm

lazydavid wrote:The match would have to be 100% on the first 4% instead of 50% on the first 8%. The results are effectively the same, since the 10% cap on HCE contributions means that the average non-HCE contribution is 8%. Therefore the "average" employee is already getting a 4% match. So our plan effectively and successfully encourages non-HCEs to take more advantage of the 401k than an equivalent safe harbor plan would (the average employee contribution would be a lot closer to 4% than 8% if we met the guidelines), and the HCEs get punished for that.


Would you take a pay cut to be classified as non-HCE?

lazydavid
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Re: 401k excess contribution/highly compensated employee

Postby lazydavid » Thu May 18, 2017 8:27 pm

Thrifty Femme wrote:Would you take a pay cut to be classified as non-HCE?


I'm actually NOT an HCE, but that doesn't change the fact that it's absurd. To answer your question: Right at the margin, yes I would take a pay cut. Losing $1,000 worth of salary to preserve $6,000 worth of tax-free space would absolutely be worth it. Giving up $30k to save $3k worth of tax-advantaged space obviously doesn't make nearly as much sense.

Edit: come to think of it, I might hit the threshold this year, between a expected well-above-plan bonus due to smashing our financial goals, and 6 weeks of vacation being paid out as management gets switched over from accrued PTO to Discretionary time-off. So in all likelihood, my wife and I will both be getting a 401k refund at the end of the year. So :happy extra money, and :( dramatically more taxes to go along with it.
Last edited by lazydavid on Thu May 18, 2017 8:50 pm, edited 2 times in total.

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rob
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Re: 401k excess contribution/highly compensated employee

Postby rob » Thu May 18, 2017 8:32 pm

Yeah it sucks.... and it's nothing to do with actual highly compensated employees.... My last few companies have limited the percentage.... so the really highly paid employee don't care as they can reach the IRS max with a reduced percentage. The whole thing is just broken and need to be fixed but it's never going to happen.
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien


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