No. of Recommendations: 0
Greetings, H2Osailing, and welcome to Fooldom.

<<Just when everything is going GREAT I open the mail and find some fluffy letter from my 401K provider about some corrective distribution (a sizeable amout) which is being returned to me. Basically it states that an HCE (highly compensated employee) is compared to a non-HCE and the IRS makes an adjustment to make life balanced. How nice!!!!

I was under the impression there is a $9500 cap on 401K contributions. Last year I maxed out and never played this game with the IRS.

Can anyone explain to me if this is correct and standard policy? and if so advise what my best options are to keep this as retirement (tax exempt money). I was not informed of this in advance to make corrections by my provider. Are they required to do so?>>

Welcome to the world of the nondiscrimination testing and the highly compensated employees! First off, the IRS doesn't make the adjustment, the plan admnistrator does because the IRS and DOL require it based on certain nondiscrimination tests.
Basically, the test looks at two groups the highly compensated employees (HCE) and the lower compensated employees (LCE). It then averages the percent of compensation each person in those groups contributes to the 401k. As a group, the HCE percentage contribution may be no more than 2% above that of the LCE. Thus, if the LCE group's contribution averages five percent of compensation, then the HCE group's contribution may not be above seven percent.

In your case, the LCE has contributed less of a percentage than the HCE, so the HCE are forced to take a refund to bring the plan within discrimination requirements. Ain't that a kick? You save more, but get penalized in the name of fairness when you do so. Such is life in the retirement plan biz.

As to keeping this money in a tax deferred status, you're out of luck. You're an HCE, so I'll be willing to bet you're well beyond the phase-out range for a deductible IRA. For those covered by work retirement plans the limit is $35K AGI for single filers and $50K AGI for married filing jointly. See IRS Pub 590 for details. You can, though invest it in an after-tax IRA where the earnings will at least compound tax deferred. Then on 1/1/98 you can roll that to a Roth IRA by paying taxes on the small growth it will have had. On retirement, you could then get all the money out totally tax free.

Just one Fool's opinion FWIW.


Print the post  


The Retirement Investing Board
This is the board for all discussions related to Investing for and during retirement. To keep the board relevant and Foolish to everyone, please avoid making any posts pertaining to political partisanship. Fool on and Retire on!
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.