Friday, November 7, 2008

This rule can limit your 401(k) contribution

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There is a little mentioned rule for 401(k) contributions that could limit the contributions (free WSJ Digg link) of the mass affluent or other high earners. The rule is in place to prevent a 401(k) plan from favoring highly compensated employees. Highly compensated is defined as making $105,000 or more in 2008 (this increases to $110,000 in 2009). The basics of the rule are:

higher wage earners can't contribute more than two percentage points more of their salaries than lower wage earners. For example, if highly compensated workers defer 6% of their wages and lower earners save only 2% of their wages, the plan would fail the nondiscrimination test.
This is not a new rule, but it will affect more highly compensated employees as rank-and file employees cut back on contributions to the 401(k) plan to pay other bills. If a 401(k) plan fails this rule, contributions from the high earners in the plan are limited or even returned.

Safe harbor and SIMPLE 401(k) plans not subject to the nondiscrimination test

The IRS has more information on 401(k)s for sponsors and participants at its 401(k) resource guide. Digging through the IRS site you can find that safe harbor and SIMPLE 401(k) plans are not subject to this nondiscrimination rule. A safe harbor 401(k) plan allows employers to make matching contributions or contributions for all eligible employees. The employer contributions are fully vested immediately. A SIMPLE 401(k) plan has different restrictions from the traditional plan, most notably that it's only available for companies with 100 or fewer employees who received at least $5,000 in compensation.