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Author: LooseChange One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75390  
Subject: Re: 401k contribution % diff. per employee Date: 4/19/2001 11:35 AM
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I suspect that since you are able to contribute 10%, that all people that can only contribute 5% make a little more than you do (even if it is only slightly more).

It is a fairly common practice within companies (especially smaller ones) to have an income threshold at which your contribution % gets cut. This is due to the disrimination testing that your plan must pass in order to remain a qualified plan as defined by the IRS. This discrimination test is in place to make sure that "highly compensated" employees are not taking unfair advantage of the plan and leaving the lower compensated employees in a disadvantaged situation. The discrimination test looks at contributions of all employees and gives the plan manager a salary boundary which defines the "highly compensated employees (regardless of how you feel about it)." I have seen this number as low as $55-60k in some companies.

Other companies (like the one I currently work for) allow everyone to contribute however much they want to (within the federal maximum guidelines). At the end of the plan year, they perform the calculation. If "highly compensated employees" have contributed too much based on the calculation, then the company does a corrective distribution in order to keep the plan qualified. This corrective distribution can really screw up your taxes because it *usually* counts as income during the year in which was deferred rather than the year it was distributed. So you have to delay filing your taxes in order to make sure you're not in trouble, and you don't know exactly what the corrective distribution will be.

Basically, it sounds like your company is doing its employees a favor by protecting them from this corrective distribution phenom. I suspect you are just below the threshold where your 401(k) contribution % will be rolled back. My personal opinion is that this formula really needs to be redone. The discrimination testing procedure is not really keeping up with salary increases in highly competitive industries (e.g., high tech engineering, etc.) You can easlily be a flunky cube sitter with 5 years experience and be considered a "highly compensated employee" while the president of the company is making 5-7 times what the cube sitter is making if you are in the right (wrong company). The formula works OK in general, but is grossly broken in some industries.

Good luck,
LooseChange
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