'Highly Compensated Worker' Can't Keep Pace with 401(K)

Dear Liz, 

I am considered a "highly compensated employee," which limits my ability to contribute to our 401(k) plan. This is true even though my salary is low ($33,600). Very few of my co-workers choose to contribute to our retirement plan, even though we have a match. Therefore, I'm allowed to contribute less than $3,000 per year for myself after (nondiscrimination) testing.

Now that I am 50, I would like to take advantage of the catch-up option, which allows older workers to contribute an additional $5,500 to the plan. Our plan, however, has a 15 percent cap on deferrals. I can't tell if the cap would prevent me from making the catch-up contribution or not. -- Cheryl

Dear Cheryl,

If you're considered a highly compensated employee, or HCE, it's not because of your salary. Two types of workers can be considered HCEs: those who made more than $115,000 this year, and those who owned more than 5 percent of the business. Presumably, you're the latter.

Federal law allows workers to put up to $17,500 into their 401(k)s in 2014 ($18,000 in 2015). But contributions by highly compensated employees can be limited to much less than that if not enough of their lower-paid brethren sign up for the plan.

Catch-up contributions get special treatment, however. Even HCEs whose regular contributions are capped are allowed to make up to $5,500 in catch-up contributions in 2014 ($6,000 in 2015).

But here's where your plan's 15 percent cap comes into play, says Mark Luscombe, principal analyst for tax research firm CCH.

"If the plan document provides for an overall 15 percent cap on contributions, without making any exception for catch-up contributions, that is the cap that would apply even though the law would have otherwise permitted a greater contribution," Luscombe says.

"A careful reading of the plan document would be required to determine if the 15 percent cap applies to all contributions, regardless of whether they are catch-up contributions or not," he says.

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