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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: of 75381  
Subject: Re: 401K Corrective Distribution Date: 10/9/1997 6:51 PM
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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.

Regards......Pixy

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