Highly Compensated Employees and 401(k) Limits
A 401(k) Plan Enables Business Owners and their Employees to Save for Retirement.
Business owners and other highly compensated employees (HCEs) often try to accelerate their retirement savings by maximizing contributions to their 401(k) plan as permitted by the IRS. If they are age 50 or older, they may be able to contribute as much as $62,000 (for 2019). Some highly compensated individuals are unable to maximize their contributions, however, if lower paid workers are not saving aggressively in their 401(k) plan.
Saving in a 401(k) is one of the best ways to achieve your retirement planning goals. Whether you own your business or are employed by someone else, you can learn about 401(k) here, putting you on the right track for a financially secure future.
If you meet either of these requirements, you may be affected by these rules, depending on the salaries and saving rates of the employees who participate in your 401(k). Fortunately, there are still plenty of methods for high earners to save for retirement.
Annual 401(k) limit for HCEs
Salary deferral limit
Under the 401(k) contribution rules, business owners and employees may deduct a portion of their pay and have it deposited into their 401(k) account as a pre-tax contribution. The amount contributed to the 401(k) will not be included in taxable income until the dollars are distributed from the plan – hopefully during their retirement years. If a 401(k) allows Roth contributions, some or all of these contributions may be made as after-tax Roth contributions. No matter which type of contribution is made, there is one maximum 401(k) limit per person – $19,000 for 2019.
If an individual defers more than $19,000 for 2019, the business owner must distribute the excess amount plus earnings to the individual. This is a taxable distribution (unless the salary deferrals were made as Roth contributions).
Catch-up contribution
In addition to potentially providing financial security in retirement, saving in a 401(k) provides tax advantages for both the business owner and the employees, including tax deductions, tax-deferred earnings, and tax credits. For example, when an employee saves in a 401(k), their contribution is deducted from their paycheck before income taxes are withheld. These pre-tax contributions lower an individual’s tax liability for the year, just for investing in their future.
Nondiscrimination test limit
Business owners and highly compensated employees may not be permitted to contribute the full salary contribution amount each year
If lower paid employees in the 401(k) plan are not making significant contributions. 401(k) plans must pass certain nondiscrimination tests each year to demonstrate that the plan is not discriminating against lower compensated employees.
If a 401(k) plan fails these tests, the business owner must either return a portion of the HCEs’ contributions or make additional contributions for the lower paid employees.
Compensation limits
If lower paid employees in the 401(k) plan are not making significant contributions. 401(k) plans must pass certain nondiscrimination tests each year to demonstrate that the plan is not discriminating against lower compensated employees
For 2019, this limit is $280,000.
For example, assume you earn $300,000 for 2019. The 401(k) plan includes an employer matching contribution of up to 3% of your compensation. Under these “compensation cap” rules, your employer could make a matching contribution of up to $8,400 (3% x the compensation cap of $280,000) – not $9,000 (3% x your full compensation of $300,000).
Strategies for HCEs and business owners
Business owners and HCEs may be able to increase the amount they can contribute to a 401(k) plan through one or more of these strategies.
Catch-up contributions
Catch-up contributions are made after an individual reaches the $19,000 (for 2019) annual salary contribution limit or a plan-imposed limit (e.g., a failed nondiscrimination test). Because catch-up contributions are not included in nondiscrimination testing, even if you cannot make the full $19,000 salary contribution because of limits imposed by a plan test, you will still be able to make a catch-up contribution, up to $6,000, if you are age 50 or older.
Increase lower-paid employees’ savings rates through education
If lower paid employees increase their saving rates, HCEs and business owners will be able to make larger contributions. To encourage employees to save more in the 401(k), business owners may want to engage financial advisors or other service providers to educate employees about the benefits of saving in a 401(k) and helping workers calculate how much they need to save to reach their financial goals in retirement.
If a business owner adopts a Safe Harbor 401(k) plan, it will be deemed to pass these nondiscrimination tests, meaning the business owner and other HCEs can contribute any amount up to the annual salary contribution limit, plus catch-up contributions if eligible, without worrying about the contribution rate of lower paid employees. Offering a Safe Harbor 401(k) plan may also help improve participation and savings rates for all employees.
Learn More
If you are a small business owner and need a 401(k) plan for yourself and your company, we can help.
Setting up a 401(k) can be complicated. The 401(k)ompany gives small business owners access to 401(k) professionals in addition to low flat-fees. Each sales professional has over a decade of experience assisting business owners in 401(k) plan design. Take advantage of this benefit.
Additional resources for 401(k) limits for HCEs
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Fort Lauderdale, FL 33301
Support: 888.667.4750
© 2019 The 401(k)ompany
200 East Broward Blvd. Suite 1320
Fort Lauderdale, FL 33301
Support: 888.667.4750
© 2022 The 401(k)ompany, All rights reserved.
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