So, I was just talking with a friend about 401k contributions because he wanted my advise as a finance guy. After discussion, I told him to max out. So, he goes to his HR and finds that he cannot contribute more than 3% of his income to his 401k because he is a “highly compensated employee”. Has anyone else heard of this? I thought the max was $17.5k for everyone.
I should have gotten that CFP.
The company probably doesn’t offer the company match for the ballers, but he should be able to contribute the full 17.5k on his own.
Maybe he earns over $583,333 per year… 
Based on my detailed internet research, it seems like this depends on the overall composition of the company employees’ contributions to the 401k program. Specifically:
“…the average contributions of highly compensated employees, as a group, cannot exceed the average contributions of nonhighly compensated employees, as a group, by more than about 2 percent… In addition to the 2 percent spread, the contributions of all HCEs as a group may not be more than two times the percentage of other employees’ contributions.”
http://www.401khelpcenter.com/mpower/feature_030702.html#.Uoui7_GHfy0
“Highly compensated employee” apparently means employees “who earned more than $115,000, or owned more than 5 percent of the business”. Not sure if that number is up to date. Anyway, this rule seems kind of stupid, but apparently exists.
Nope, only able to contribute about $4k.
Tax the rich!!!1!!1
I don’t really understand that. We don’t have that problem here. It’s not uncommon at all to max out your 401k by the spring time.
Well, my friend is in sales and there are a lot of people that are just starting out, probably don’t make any real money and don’t contribute anything to the 401k, so maybe it makes sense in that case?
I guess participation in retirement plans at financial firms is probably higher than at non-financial firms, for obvious reasons.
Most companies will probably pass the test without issues, and their employees will not be refunded 401k contributions.
“the average contributions of highly compensated employees, as a group, cannot exceed the average contributions of nonhighly compensated employees, as a group, by more than about 2 percent”
This is ambiguously worded, but the 2 percent limit here is a percentage of compensation, not dollars contributed. So if the average non-highly paid employee contributes 10% of compensation, the average highly paid employee can contribute 12% of compensation. Imagine that a highly compensated employee is paid $300k in a year. A $17.5k maximum contribution is only 5.83% of compensation. So, as long as the average contribution of non-highly paid employees is less than 3.83%, everything is fine.
“In addition to the 2 percent spread, the contributions of all HCEs as a group may not be more than two times the percentage of other employees’ contributions”
This is pretty easy to pass if the ratio of non-HCEs to HCEs is high.
Is there nothing in your tax laws down there that is common sense or simple?
Only that you’ll get audited if you’re a republican.
What if you work for a boutique IB and the only non-HCEs are support workers? You just force them to contribute or really, really incentivize them I guess.
That’s probably why companies in high paying industries have such good matching programs. The reason companies match, for example, 50% of your first 8% is to encourage a higher savings rate than if they matched 100% of your first 4%. I thought the folks in HR were just looking out for the employees and trying to get them to save for retirement. Maybe they really do that so the HCE’s can max out.
Ohai is generally right. IRS Code Section 414q defines an HCE as:
Somebody who is a 5% owner of the company (or WAS a 5% owner at any point in time during the prior year, -OR-
received more than $115k in compensation, and if the employer elects, was also in the “top-paid group” (which I believe is the top 20%)
Further, according the Code Section 401(a)(4), benefits to a qualified retirement plan must not discriminate in favor of “highly compensated employees”. To comply, a plan must satisfy three requirements:
What does this actually mean? I have no idea, but you can look at Reg. 1.401(a)(4)-1(b) to see for yourself.
Being limited to only 3% seems a bit severe, but as others have suggested I suspect it is a function of non-HCE’s having a very low contribution rate. My company had a division that employed a ton of low wage, low skill workers who generally contributed very little to their 401(k)'s. As a result, I got a “refund” every year of part of my contribution, a taxable event - yeah! We recently sold that division and the participation rate for non-HCE’s in other divisions is supposedly adequate that I’ll be able to max again.
Canadian income taxes are no walk in the park either… there are so many random deductions and credits to wade through, not to mention different rules for provincial and federal (US has that too). One of the nice things though is one year Canada Revenue sent me a larger refund than I expected because they realized I was eligible for a credit that I didn’t apply for. IRS isn’t that nice.
A wise man once said that tax law is the result of political forces, not economical ones. So they’re not really required to make economical sense. But they tend to make a lot of political sense.
There are certainly a ton of random tax credits, but in general I find our personal tax system quite a bit more simplified. We will see how income splitting and such impacts that.
On the corporate side our system is a complex mess too. I don’t have any experience at all in US corporate taxes so I can’t compare, but I understand there is much greater use of flow through tax structures down there, potentially to avoid such mess?
In comparison to 401(k)'s, our RRSPs are relatively simply as a percentage of income up to a cap. What my co-workers contribute doesn’t impact my max. I find that absolutely bizarre.
On the topic of retirement accounts, anyone that is or will be a student should consider converting traditional 401k’s or IRA’s into Roth. Doing so was one of the best decisions I made while I was in business school, since I had the lowest conversion taxes thanks to my trough earnings (i.e. no $ except from internships, career coaching, and professional cuddling services of course).