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I contribute about 13% of my income to my company's 401k, which, at my salary, is well below the IRS limit of $17K/year (in 2012). However, with my raise this year, my benefits department told me that they limit contributions to 9% of my salary above a certain income level - and my raise this year puts me just over that salary, so my total contribution amount will go down significantly for next year. I was told they're doing it to prevent discrimination of some kind, but I couldn't get any more detail.

I'm allowed by the tax code to give up to $17K, and even at my old percentage and my new salary, I'm still well below that limit. Is my employer allowed to impose their own limit on my contributions that's different from the IRS limit? Is it something they can limit at will, or are they required to allow me to contribute up to the IRS limit?

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Related discussions can be found here and there. –  Dilip Sarwate Jul 23 '13 at 19:49

6 Answers 6

up vote 20 down vote accepted

Congratulations on your raise!

Is my employer allowed to impose their own limit on my contributions that's different from the IRS limit?

No.

Is it something they can limit at will, or are they required to allow me to contribute up to the IRS limit?

The employer cannot limit you, you can contribute up to the IRS limit.

Your mistake is in thinking that the IRS limit is 17K for everyone. That is not so.

You're affected by the HCE rules (Highly Compensated Employees). These rules define certain employees as HCE (if their salary is significantly higher than that of the rest of the employees), and limit the ability of the HCE's to deposit money into 401k, based on the deposits made by the rest of the employees. Basically it means that while the overall maximum is indeed 17K, your personal (and other HCE's in your company) is lowered down because those who are not HCE's in the company don't deposit to 401k enough.

You can read more details and technical explanation about the HCE rules in this article and in this blog post.

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After a bit of reading, this appears to be exactly what's happening. Thanks! –  SqlRyan Dec 19 '12 at 22:04
    
+1 Nice answer and links. By providing an adequate match, the lower limit would be removed. I agree the rule is IRS code based but the employer has the ability to avoid this issue. –  JoeTaxpayer Dec 19 '12 at 22:18
    
@joe the employer can give incentives (match), but bottom line is that if 90% of the employees earn <50K, those 5% who earn >$100K will be screwed. People do prefer to be able to feed their children now rather than themselves later.... –  littleadv Dec 19 '12 at 22:21
    
However, the employer's 401k plan can limit range of the percentage of your pay you choose to contribute (i.e. they can say you cannot choose to contribute 100%). –  user102008 Dec 20 '12 at 0:54
    
@user102008 that is, also, an IRS rule (a tax code requirement in fact). Not an employer's choice. The employer cannot restrict you, if you want to deposit 100% of your salary, but they don't have to deposit the excess over the maximum allowed (or, if they do, you're the one to pay the 6% yearly tax, until you withdraw). –  littleadv Dec 20 '12 at 1:01

Highly Compensated Employee Rules Aim to Make 401k's Fair would be the piece that I suspect you are missing here. I remember hearing of this rule when I worked in the US and can understand why it exists. A key quote from the article:

You wouldn't think the prospect of getting money from an employer would be nerve-wracking. But those jittery co-workers are highly compensated employees (HCEs) concerned that they will receive a refund of excess 401k contributions because their plan failed its discrimination test. A refund means they will owe more income tax for the current tax year. Geersk (a pseudonym), who is also an HCE, is in information services and manages the computers that process his firm's 401k plan.

401(k) - Wikipedia reference on this:

To help ensure that companies extend their 401(k) plans to low-paid employees, an IRS rule limits the maximum deferral by the company's "highly compensated" employees, based on the average deferral by the company's non-highly compensated employees. If the less compensated employees are allowed to save more for retirement, then the executives are allowed to save more for retirement. This provision is enforced via "non-discrimination testing". Non-discrimination testing takes the deferral rates of "highly compensated employees" (HCEs) and compares them to non-highly compensated employees (NHCEs). An HCE in 2008 is defined as an employee with compensation of greater than $100,000 in 2007 or an employee that owned more than 5% of the business at any time during the year or the preceding year.[13] In addition to the $100,000 limit for determining HCEs, employers can elect to limit the top-paid group of employees to the top 20% of employees ranked by compensation.[13] That is for plans whose first day of the plan year is in calendar year 2007, we look to each employee's prior year gross compensation (also known as 'Medicare wages') and those who earned more than $100,000 are HCEs. Most testing done now in 2009 will be for the 2008 plan year and compare employees' 2007 plan year gross compensation to the $100,000 threshold for 2007 to determine who is HCE and who is a NHCE. The threshold was $110,000 in 2010 and it did not change for 2011.

The average deferral percentage (ADP) of all HCEs, as a group, can be no more than 2 percentage points greater (or 125% of, whichever is more) than the NHCEs, as a group. This is known as the ADP test. When a plan fails the ADP test, it essentially has two options to come into compliance. It can have a return of excess done to the HCEs to bring their ADP to a lower, passing, level. Or it can process a "qualified non-elective contribution" (QNEC) to some or all of the NHCEs to raise their ADP to a passing level. The return of excess requires the plan to send a taxable distribution to the HCEs (or reclassify regular contributions as catch-up contributions subject to the annual catch-up limit for those HCEs over 50) by March 15 of the year following the failed test. A QNEC must be an immediately vested contribution.

The annual contribution percentage (ACP) test is similarly performed but also includes employer matching and employee after-tax contributions. ACPs do not use the simple 2% threshold, and include other provisions which can allow the plan to "shift" excess passing rates from the ADP over to the ACP. A failed ACP test is likewise addressed through return of excess, or a QNEC or qualified match (QMAC).

There are a number of "safe harbor" provisions that can allow a company to be exempted from the ADP test. This includes making a "safe harbor" employer contribution to employees' accounts. Safe harbor contributions can take the form of a match (generally totaling 4% of pay) or a non-elective profit sharing (totaling 3% of pay). Safe harbor 401(k) contributions must be 100% vested at all times with immediate eligibility for employees. There are other administrative requirements within the safe harbor, such as requiring the employer to notify all eligible employees of the opportunity to participate in the plan, and restricting the employer from suspending participants for any reason other than due to a hardship withdrawal.

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Aah - this makes sense, and it would explain what I'm seeing. I can understand why it's in place, and it just means moving desired contributions beyond that limit to another place, like a Roth IRA. Thanks for your help! –  SqlRyan Dec 19 '12 at 21:56
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Could you summarized or get the relavent quote from the link to prevent this great answer from being spoiled by link rot. Thanks –  user4127 Dec 19 '12 at 22:31

One description of what happened is at 401(k) Plan Fix-It Guide.

The issue is the plan was "Top Heavy," i.e. those making a high income were making disproportionately larger deposits than the lower paid employees. As the IRS article suggests, a nice matching deposit from the employer can eliminate the lower limit caused by the top heavy-ness.

Searching on [top heavy 401(k)] will yield more details if you wish to research more.

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Hmm - this makes sense, and it would fit the "to avoid discrimination" non-answer I got when I asked why it was happening. Interesting to know - thanks! –  SqlRyan Dec 19 '12 at 21:47

On thing the questioner should do is review the Summary Plan Description (SPD) for the 401(k) plan. This MAY have details on any plan imposed limits on salary deferrals. If the SPD does not have sufficient detail, the questioner should request a complete copy of current plan document and then review this with someone who knows how to read plan documents.

The document for a 401(k) plan CAN specify a maximum percentage of compensation that a participant in the 401(k) plan can defer REGARDLESS of the maximum dollar deferral limit in Internal Revenue Code Section 402(g). For example, the document for a 401(k) plan can provide that participants can elect to defer any amount of their compensation (salary) BUT not to exceed ten percent (10%). Thus, someone whose salary is $50,000 per year will effectively be limited to deferring, at most, $5,000. Someone making $150,000 will effectively be limited to deferring, at most, $15,000. This is true regardless of the fact that the 2013 dollar limit on salary deferrals is $17,500. This is also true regardless of whether or not a participant may want to defer more than ten percent (10%) of compensation.

This "plan imposed" limit on salary deferral contributions is permissible assuming it is applied in a nondiscriminatory manner. This plan imposed limit is entirely separate from any other rules or restrictions on salary deferral amounts that might be as a result of things like the average deferral percentage test.

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I merged in the text from your other answer. Thanks for posting. –  Chris W. Rea Jul 23 '13 at 20:34

Companies are required BY THE IRS to try to get everybody to contribute minimal amounts to the 401K's. In the past, there were abuses and only the execs could contribute and the low paid workers were starving while the execs contributed huge amounts.

On a year-by-year basis, if the low-paid employees don't contribute, the IRS punishes the high paid employees. Therefore, most employers provide a matching program to incentivize low-paid employees to contribute.

This 9% limitation could happen in any year and it could have happened even before you got your pay raise, what matters is what the low-paid employees were doing at your company LAST YEAR.

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YMMV, but I don't accept non-answers like that from HR. Sometimes you need to escalate. Usually when I get this sort of thing, I go to my boss and he asks them the question in writing and they give him a better answer. (HR in most companies seem to be far more willing to give information to managers than employees.) Once we both had to go to our VP to get HR to properly listen to and answer the question. Policies like this which may have negative consequences (your manager could lose a good employee over this depending on how to close to retirement you are and how much you need to continue making that larger contribution) that are challenged by senior managment have a better chance of being resolved than when non-managment employees bring up the issue.

Of course I havea boss I know will stand up for me and that could make a difference in how you appraoch the problem.

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In this case, I AM the boss, so I'm really wondering if this is something I should be escalating. Rather than an official tax answer, I just wanted to do the BS check to see if other employers do this or other employees have experienced it, before I go asking questions. Thanks! –  SqlRyan Dec 19 '12 at 21:42

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