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Author: edmay Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75622  
Subject: 401(k) and Highly Compensated Employees Date: 8/2/1999 10:49 AM
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Does anyone have information on the Highly Compensated Employee provision of 401(k) plans. I've been contributing to my 401(k) for several years now but I think I may be moving into HCE territory this year.

I'm looking to contribute the maximum of 10K this year, but some of what I've read concerning HCE seems to say that if I'm a HCE that I won't be able to contribute the maximum.

Is my employer responsible for determining this status or is it me? Is it possible to overcontribute? What happens to that "overflow"? Will I be penalized 10% because I didn't understand whatever convoluted formula the IRS comes up with to determine my real maximum?

Any help would be appreciated. Thanks.

Ed
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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12701 of 75622
Subject: Re: 401(k) and Highly Compensated Employees Date: 8/2/1999 11:18 AM
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Greetings, Ed, and welcome. You wrote:

<<Does anyone have information on the Highly Compensated Employee provision of 401(k) plans. I've been contributing to my 401(k) for several years now but I think I may be moving into HCE territory this year.

I'm looking to contribute the maximum of 10K this year, but some of what I've read concerning HCE seems to say that if I'm a HCE that I won't be able to contribute the maximum.

Is my employer responsible for determining this status or is it me? Is it possible to overcontribute? What happens to that "overflow"? Will I be penalized 10% because I didn't understand whatever convoluted formula the IRS comes up with to determine my real maximum?>>


Your employer's benefits folks will keep track of this issue. Basically, if you are in the highly compensated employee group you may find your contributions limited to less than $10K. That's because the HCE's average deferral percentage may not exceed the average deferral percentage of the lower compensated group by more than 2%. In short, if the LCE as a group average a contribution of 5% of compensation, the HCE may not contribute more than 7% or $10K, whichever is less.

If you over-contribute, be assured the money will be refunded to you by your plan administrator. It then becomes taxable income. However, you will not be penalized on that refund.

Regards..Pixy

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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12704 of 75622
Subject: Re: 401(k) and Highly Compensated Employees Date: 8/2/1999 11:50 AM
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Without belaboring the details there are really two issues here:

1. Who is a highly compensated employee? Generally, anyone who is in the top 20% of all paid employees, or earns over $80,000 ish, or is an officer of the corp. or owns more than 5% of the corp. These rules & definitions are set in the Internal Revenue Code. Your employer can do nothing about them.

2. Every 401(k) plan (except those safe-harbored) must perform the annual ADP (actual deferral percentage) test that compares the contribution percentages of HCE's against the contribution percentages of non-HCE's --- kind of a complicated tetter-totter test. If the plan fails the test and it is not corrected, the plan gets disqualified. The corrective measures (when the test is failed) is to reduce the percetage of contribution (and thus dollars) allowable for the HCE's until things come back into balance.

Regarding your situation, there is little that either you or your employer can do. Sorry.

TheBadger


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Author: edmay Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12705 of 75622
Subject: Re: 401(k) and Highly Compensated Employees Date: 8/2/1999 11:51 AM
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That's because the HCE's average deferral percentage may not exceed the average deferral percentage of the lower compensated group by more than 2%. In short, if the LCE as a group average a contribution of 5% of compensation, the HCE may not contribute more than 7% or $10K, whichever is less.

Thanks for the quick response!

My contribution is going to be limited by what others have contributed? Is this for my firm or the whole country? I know these are IRS regulation we're talking about, but what could possibly be the logic behind this? Besides the IRS getting a whack at more of my money that is?

Ed

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Author: cfofool Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12707 of 75622
Subject: Re: 401(k) and Highly Compensated Employees Date: 8/2/1999 12:12 PM
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The calculation only applies to your firm.

The logic is that they are trying to make sure the "benefits" of the tax deferral are not going mainly to the HCEs. There are also "top-heavy" rules regarding this.

One step employers often take who are in danger of limiting contributions for HCEs is to add a matching feature (or improve the one they have). This often brings new money into the plan. I believe there is a new "safe harbour" in the regs whereby if you offer a generous enough match (I think 3% of pay for all ees whether they contribute or not) you don't have to subject your plan to this test.

Hope this helps,

Kevin

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Author: KGWood One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 12717 of 75622
Subject: Re: 401(k) and Highly Compensated Employees Date: 8/2/1999 2:31 PM
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If HCE testing appears to be a problem for your employer, I wonder if they've set up a "Non-qualified Plan" exclusively for HCE's.

I'm not a specialist, but 401k's, 403b's, pension plans and the like are "Qualified Plans" - meaning they are subject to ERISA (this is the acronym - please don't ask me what it stands for! - for the legislation that governs all of these types of plans). Employers will often times set up Non-Qualified plans - mostly for the executives/HCE's - as an added benefit above and beyond what is permitted in the Qualified Plans. These Qualified Plans are NOT subject to the rules, regulations, AND PROTECTIONS of ERISA.

I am aware that many employers that have 401k plans that have HCE testing problems will set up a Non-Qualified Plan that will essentially 'mirror' the 401k plan. This means essentially that it has all of the same investment options as the regular 401k plan. You as a participant in the non-qual. plan would then contribute above-and-beyond what you put into the regular 401k plan. The Non-Qual. Plan would have the same tax-deferral benefits as the regular 401k - someone more versed in this than I would have to explain differences - if any - in taxation when you either retire or just plain leave that employer.

All-in-all, it would seem like something you may want to ask about if you will be an HCE. If they don't offer it, maybe you and the other HCE's can encourage them to set one up. Good Luck!

Ken

P.S. It's my understanding that the big risk with a lot of Non-Qual. Plans is if they are "unfunded." This means that the dollars in the Plan are not actually funded with cash but are effectively an IOU to the participants from the employer. This often happens when a non-qual. plan is set up to cover a portion of an employer's bonus program to its executives. In this case, if the employer goes belly-up, the participant is just another unsecured creditor of the employer- yuck!! In the "mirror" plan I mentioned above, you would be funding the plan with your contributions, so the cash would be there - BUT, I think the cash continues to be an asset of the employer (not sure, though). Upsides and downsides to everything.....

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