Post by yellowbrkrd on May 14, 2012 8:01:19 GMT -5
On Friday DH received a large check from his 401K account. We kind of panicked because we had no idea why they would cash out any portion. On the statement it said "withdrawal of excess annual additions". This didn't make any sense to us because he had only been contributing since October (new to the company) and obviously didn't put in more than the annual max.
John Hancock told us to call the administrator at his office. Basically the CFO said: "Per IRS guidelines our 401k must be tested for compliance. One area of testing relates to highly compensated individuals. This group is compared to all of the non highly comp'd personnel. If the percentage is out of alignment, then a return of what was invested is required to get the total dollars of Highly comp'd to a level that meets IRS guidelines."
Soooo basically DH is punished because the rest of the company isn't contributing to their retirement.
We've never run across this before....and I find it completely sucky. He was only contributing 10% this year and we were going to bump it up to 15% when he got a raise in a couple of months. There is no way we'll be able to save enough for retirement if this keeps happening. We needed the push to open a few ROTH IRAs so I guess that's what we'll be doing.
Just remember that you will probably be taxed on this check. Since the money went into the 401k pre-tax, you will get a 1099R for the amount of this "excess contribution" and have to pay taxes on it.
This policy is frustrating. Many firms contribute a "safe harbor" amount to get around this rule, but if they don't, there is a formula that determines how much HCE's (highly compensated employees) may contribute. It might vary slightly from year to year, and I don't know any other way to max it out other than to put in as much as you can and get these checks after the fact.
Post by thatgirl2478 on May 14, 2012 9:20:55 GMT -5
Just check the rules on the Roth IRA - if you're above a certain income level you don't qualify for them . If he's a high earner, that may be the case for you. If you can't open a roth, a traditional IRA can be an OK place to stash the money, but since you probably can't deduct that contribution come tax time and you will be taxed on the earnings, you may be able to find a better place for it.
And yes, you will more than likely be taxed on the check.
To help ensure that companies extend their 401(k) plans to low-paid employees, an IRS rule limits the maximum deferral by the company's "highly compensated" employees, based on the average deferral by the company's non-highly compensated employees. If the less compensated employees are allowed to save more for retirement, then the executives are allowed to save more for retirement. This provision is enforced via "non-discrimination testing". Non-discrimination testing takes the deferral rates of "highly compensated employees" (HCEs) and compares them to non-highly compensated employees (NHCEs). An HCE in 2008 is defined as an employee with compensation of greater than $100,000 in 2007 or an employee that owned more than 5% of the business at any time during the year or the preceding year.[9] In addition to the $100,000 limit for determining HCEs, employers can elect to limit the top-paid group of employees to the top 20% of employees ranked by compensation.[9] That is for plans whose first day of the plan year is in calendar year 2007, we look to each employee's prior year gross compensation (also known as 'Medicare wages') and those who earned more than $100,000 are HCEs. Most testing done now in 2009 will be for the 2008 plan year and compare employees' 2007 plan year gross compensation to the $100,000 threshold for 2007 to determine who is HCE and who is a NHCE. The threshold is $110,000 in 2010 and was not changed for 2011.[10]
The average deferral percentage (ADP) of all HCEs, as a group, can be no more than 2 percentage points greater (or 125% of, whichever is more) than the NHCEs, as a group. This is known as the ADP test. When a plan fails the ADP test, it essentially has two options to come into compliance. It can have a return of excess done to the HCEs to bring their ADP to a lower, passing, level. Or it can process a "qualified non-elective contribution" (QNEC) to some or all of the NHCEs to raise their ADP to a passing level. The return of excess requires the plan to send a taxable distribution to the HCEs (or reclassify regular contributions as catch-up contributions subject to the annual catch-up limit for those HCEs over 50) by March 15 of the year following the failed test. A QNEC must be an immediately vested contribution.
The annual contribution percentage (ACP) test is similarly performed but also includes employer matching and employee after-tax contributions. ACPs do not use the simple 2% threshold, and include other provisions which can allow the plan to "shift" excess passing rates from the ADP over to the ACP. A failed ACP test is likewise addressed through return of excess, or a QNEC or qualified match (QMAC).
There are a number of "safe harbor" provisions that can allow a company to be exempted from the ADP test. This includes making a "safe harbor" employer contribution to employees' accounts. Safe harbor contributions can take the form of a match (generally totaling 4% of pay) or a non-elective profit sharing (totaling 3% of pay). Safe harbor 401(k) contributions must be 100% vested at all times with immediate eligibility for employees. There are other administrative requirements within the safe harbor, such as requiring the employer to notify all eligible employees of the opportunity to participate in the plan, and restricting the employer from suspending participants for any reason other than due to a hardship withdrawal.