HCE notice what do I need to do?

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pindevil
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HCE notice what do I need to do?

Post by pindevil » Tue Mar 14, 2017 9:23 am

My wife just received an email letting her know she will be getting money back from her 401k due to HCE rules. The email did not mention dollar amounts or any other details. I have two questions.

Do we pay taxes for the same year we receive the check? So if we receive the check in 2017 it will be for 2017 taxes?

One of my wife's friends at the same employer is in a higher ranking position and claims they always max out their 401k and never had an issue with getting money back from their 401k (even now as my wife is being told she contributed too much.) How is this possible?

ERISA Stone
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Re: HCE notice what do I need to do?

Post by ERISA Stone » Tue Mar 14, 2017 9:39 am

For an ADP/ACP Test failure, the excess contribution and attributable earnings are taxed in the year of the distribution.

I cannot tell you how your friend does not receive refunds if she is maxing out her contribution. Refunds go to the participants with the highest dollar deferral amount. Maybe she's over 50 and isn't maxing out her catch-up contribution? If this were the case, any refunds up to the catch-up limit can be reclassified as a catch-up contribution.

Topic Author
pindevil
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Re: HCE notice what do I need to do?

Post by pindevil » Tue Mar 14, 2017 10:04 am

Thanks for the reply.

I am also wondering what should we do with the money being returned to us? We already do the max contribution on our roth ira.

What can the employer do to help with my wife's situation?

ERISA Stone
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Re: HCE notice what do I need to do?

Post by ERISA Stone » Tue Mar 14, 2017 11:26 am

pindevil wrote:Thanks for the reply.

I am also wondering what should we do with the money being returned to us? We already do the max contribution on our roth ira.

What can the employer do to help with my wife's situation?
You can always invest the funds in a taxable account.

As for the employer, they could amend the plan to allow for a safe harbor contribution. This would provide an exemption from the ADP/ACP nondiscrimination tests. However, safe harbor contributions are 100% vested, and the election to provide one must be made prior to the beginning of the plan year.

livesoft
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Re: HCE notice what do I need to do?

Post by livesoft » Tue Mar 14, 2017 11:36 am

It is not as much hassle as it was in the past to get a corrective distribution from an excess ... to a 401(k) plan. So what you do is:

0. Do not file your 2016 tax return until you get the check and figure out what you need to do.

1. Search bogleheads.org for "corrective distribution of excess contribution HCE" and away you go.

2. For confirmation, search irs.gov for "corrective distribution of excess contribution HCE". You get to read IRS Publication 525 where on page 10 it tells the taxpayer what to do in this situation. https://www.irs.gov/pub/irs-pdf/p525.pdf

3. Do not confuse "excess contribution" with "excess deferral" because they are treated slightly differently.

I had this happen to me a couple of times. What the employer did was put me on the 401(k) committee and I helped change the plan to one with index funds and made it a safe-harbor plan as well. No more HCE problems.
Last edited by livesoft on Tue Mar 14, 2017 11:43 am, edited 1 time in total.
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killjoy2012
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Re: HCE notice what do I need to do?

Post by killjoy2012 » Tue Mar 14, 2017 11:41 am

pindevil wrote:One of my wife's friends at the same employer is in a higher ranking position and claims they always max out their 401k and never had an issue with getting money back from their 401k (even now as my wife is being told she contributed too much.) How is this possible?
ERISA Stone wrote:I cannot tell you how your friend does not receive refunds if she is maxing out her contribution.
I can, it's quite common, and a reason I think the whole concept of HCE is just dumb. Consider:

Employee A is HCE and makes $150k/year.
Employee B is HCE and makes $200k/year.
HCE rules limit employee contributions to 10% max.
IRS max contribution limits is $18,500/year.

Employee A maxes at 10%, for a total contribution of $15k. Under the IRS limit.
Employee B maxes at 10% for a total contribution of $20k, of which her employer reduces her last few contributions to hit the IRS max of $18.5k. Employee B, despite being limited to the same HCE rules as Employee A, is able to hit the max IRS contribution since her salary is higher.

Therefore, the only people penalized by HCE rules are those that make just enough to qualify as HCE, but not enough to be able to hit the IRS annual max based on their salary x the % limit. e.g. assuming the 10% HCE limit, only those with salaries between $120k-185k would be unable to hit the IRS max at a 10% contribution rate. Meanwhile, your CEO/COO/CIOs who make the big bucks could care less about HCE since it doesn't even affect them.

Makes sense, huh?

ERISA Stone
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Re: HCE notice what do I need to do?

Post by ERISA Stone » Tue Mar 14, 2017 11:53 am

killjoy2012 wrote:
pindevil wrote:One of my wife's friends at the same employer is in a higher ranking position and claims they always max out their 401k and never had an issue with getting money back from their 401k (even now as my wife is being told she contributed too much.) How is this possible?
ERISA Stone wrote:I cannot tell you how your friend does not receive refunds if she is maxing out her contribution.
I can, it's quite common, and a reason I think the whole concept of HCE is just dumb. Consider:

Employee A is HCE and makes $150k/year.
Employee B is HCE and makes $200k/year.
HCE rules limit employee contributions to 10% max.
IRS max contribution limits is $18,500/year.

Employee A maxes at 10%, for a total contribution of $15k. Under the IRS limit.
Employee B maxes at 10% for a total contribution of $20k, of which her employer reduces her last few contributions to hit the IRS max of $18.5k. Employee B, despite being limited to the same HCE rules as Employee A, is able to hit the max IRS contribution since her salary is higher.

Therefore, the only people penalized by HCE rules are those that make just enough to qualify as HCE, but not enough to be able to hit the IRS annual max based on their salary x the % limit. e.g. assuming the 10% HCE limit, only those with salaries between $120k-185k would be unable to hit the IRS max at a 10% contribution rate. Meanwhile, your CEO/COO/CIOs who make the big bucks could care less about HCE since it doesn't even affect them.

Makes sense, huh?
In your scenario, I would assume EE A is the OP's wife and EE B is the "higher ranking" friend. Using your numbers, if a refund was due, EE B would receive at least a $3k refund before one would be considered for EE A.

Also, "fair" is a relative concept. Under your scenario, EE A was able to defer 10% of his compensation, while EE B is capped at 9%. EE B could make a valid point that he's being treated unfairly in comparison to EE A.

The 2017 402(g) limit (maximum 401k deferral) is $18k. https://www.standard.com/eforms/10854.pdf

Topic Author
pindevil
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Re: HCE notice what do I need to do?

Post by pindevil » Wed Mar 15, 2017 12:18 am

Thank you all for the information it has been most helpful.

nolesrule
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Re: HCE notice what do I need to do?

Post by nolesrule » Wed Mar 15, 2017 8:03 am

The issue is actually the other way around in how it is unfair to the lower-paid HCEs. The lower paid HCE requires a higher percentage to meet the deferral maximum, yet it is the higher percentage contributors that will have their deferrals returned first in order to lower the percentage to meet the testing compliance.

Someone making $120k requires 15% to hit the 18k deferral limit.

Someone making $225k requires 8% to hit the 18k deferral limit.

Let's say those are the only 2 HCEs. If the non-HCEs test out to 6%, then the HCEs must be no higher than 8%. So the person making $225k gets the full deferral, but the person making $120k can only defer $9600.

ERISA Stone
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Re: HCE notice what do I need to do?

Post by ERISA Stone » Wed Mar 15, 2017 8:12 am

nolesrule wrote:The issue is actually the other way around in how it is unfair to the lower-paid HCEs. The lower paid HCE requires a higher percentage to meet the deferral maximum, yet it is the higher percentage contributors that will have their deferrals returned first in order to lower the percentage to meet the testing compliance.
That's not correct. The percentages of the highest contributors are used to determine how much to refund for the plan total, not on an individual level. Refunds start with the HCEs who contribute the highest dollar amount.

nolesrule
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Re: HCE notice what do I need to do?

Post by nolesrule » Wed Mar 15, 2017 8:20 am

ERISA Stone wrote:
nolesrule wrote:The issue is actually the other way around in how it is unfair to the lower-paid HCEs. The lower paid HCE requires a higher percentage to meet the deferral maximum, yet it is the higher percentage contributors that will have their deferrals returned first in order to lower the percentage to meet the testing compliance.
That's not correct. The percentages of the highest contributors are used to determine how much to refund for the plan total, not on an individual level. Refunds start with the HCEs who contribute the highest dollar amount.
I guess I misunderstood the calculation explanation that I read.

ERISA Stone
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Re: HCE notice what do I need to do?

Post by ERISA Stone » Wed Mar 15, 2017 8:26 am

nolesrule wrote:
ERISA Stone wrote:
nolesrule wrote:The issue is actually the other way around in how it is unfair to the lower-paid HCEs. The lower paid HCE requires a higher percentage to meet the deferral maximum, yet it is the higher percentage contributors that will have their deferrals returned first in order to lower the percentage to meet the testing compliance.
That's not correct. The percentages of the highest contributors are used to determine how much to refund for the plan total, not on an individual level. Refunds start with the HCEs who contribute the highest dollar amount.
I guess I misunderstood the calculation explanation that I read.
To give an example, suppose there are two HCEs - an owner who makes $180k and defers $18k, or 10%. The 2nd HCE makes $130k and defers 12%, or $15,600. Now suppose the NHCE average deferral rate (ADR) is 8%. That means the HCE ADR should be no more than 10%, or a refund is due. The ADR for HCEs in this example is 11%. To determine the refund, first order the HCEs in terms of deferral rate highest to lowest:

HCE 2 - 12%
HCE 1 - 10%

To get to an average of 10%, HCE 2's rate needs to be dropped to 10%. To achieve a 10% deferral rate, HCE 2 would've deferred $2600 less. So the refund amount FOR THE PLAN is $2600.

The next step is to order the HCEs by total dollar deferred:

HCE 1 - $18k
HCE 2 - $15,600

Because HCE 1 deferred $2400 more than HCE 2, the first $2400 refunded goes to HCE 1. The next $200 is split evenly between them. Refunds are:

HCE 1 - $2500
HCE 2 - $100

As you can see, it doesn't matter who actually deferred the highest percentage, other than to calculate the total amount to be refunded. The actual refund is based on dollar amount deferred.

nolesrule
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Re: HCE notice what do I need to do?

Post by nolesrule » Wed Mar 15, 2017 8:47 am

Thanks for the example. I definitely misunderstood what I was reading.

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