Non-qualified Savings Plan vs. 401(k) for Highly Compensated Employee

Question

Late last year, I started a higher-paying job than I've ever had. Today I got a letter from my employer's benefits department and Fidelity telling me that I'm expected to pass $115,000 in compensation this year, making me a "Highly Compensated Employee". Yay!

Unfortunately, as an HCE, I'm apparently not allowed to put more than 3% of my income into the company 401(k). Instead, I'm being offered a Non Qualified Savings Plan.

As far as I can tell, the differences between this and a 401(k) are:

1. I am allowed to put up to $50,000 into it vs. 3% of my wage (around $3500) for a 401(k)
2. I must choose, right now, how I want my distribution, and my choices seem to be "lump sum", "over five years", or "over ten years".
3. The distribution in (2) starts when I leave the company, and cannot be rolled into an IRA or 401(k) and thus is taxable that year.
4. There is no 10% penalty if (2) happens before I am 59.5 years old
5. A NQSP is just another liability of the company and is not segregated the way that a 401(k) is; if the company goes bankrupt, I'm just another creditor.

Is there anything I'm missing? Are there any other advantages or disadvantages I should know about?

Also, in (5), is it considered unpaid wages? Because that's pretty high on the bankruptcy hierarchy.

If I stay at this job through the end of 2013 (it's an hourly contract position and not particularly stable), my income will be around $120k - $125k for 2013; Would it be worth it to take a few extra weeks off over the year and keep myself below $115k?

Answer 1

401k plans are required to not discriminate against the non-HCE participants, and one way they achieve this is by limiting the percentage of wages that HCEs can contribute to the plan to the average annual percentage contribution by the non-HCE participants or 3% whichever is higher. If most non-HCE employees contribute only 3% (usually to capture the employer match but no more), then the HCEs are stuck with 3%. However, be aware that in companies that award year-end bonuses to all employees, many non-HCEs contribute part of their bonuses to their 401k plans, and so the average annual percentage can rise above 3% at the end of year. Some payroll offices have been known to ask all those who have not already maxed out their 401k contribution for the year (yes, it is possible to do this even while contributing only 3% if you are not just a HCE but a VHCE) whether they want to contribute the usual 3%, or a higher percentage, or to contribute the maximum possible under the nondiscrimination rules. So, you might be able to contribute more than 3% if the non-HCEs put in more money at the end of the year.

With regard to NQSPs, you pretty much have their properties pegged correctly. That money is considered to be deferred compensation and so you pay taxes on it only when you receive it upon leaving employment. The company also gets to deduct it as a business expense when the money is paid out, and as you said, it is not money that is segregated as a 401k plan is. On the other hand, you have earned the money already: it is just that the company is "holding" it for you. Is it paying you interest on the money (accumulating in the NQSP, not paid out in cash or taxable income to you)? Would it be better to just take the money right now, pay taxes on it, and invest it yourself?

Some deferred compensation plans work as follows. The deferred compensation is given to you as a loan in the year it is earned, and you pay only interest on the principal each year. Since the money is a loan, there is no tax of any kind due on the money when you receive it. Now you can invest the proceeds of this loan and hopefully earn enough to cover the interest payments due. (The interest you pay is deductible on Schedule A as an Investment Interest Expense). When employment ceases, you repay the loan to the company as a lump sum or in five or ten annual installments, whatever was agreed to, while the company pays you your deferred compensation less taxes withheld. The net effect is that you pay the company the taxes due on the money, and the company sends this on to the various tax authorities as money withheld from wages paid. The advantage is that you do not need to worry about what happens to your money if the company fails; you have received it up front. Yes, you have to pay the loan principal to the company but the company also owes you exactly that much money as unpaid wages. In the best of all worlds, things will proceed smoothly, but if not, it is better to be in this Mexican standoff rather than standing in line in bankruptcy court and hoping to get pennies on the dollar for your work.

Answer 2

Also, in (5), is it considered unpaid wages? Because that's pretty high on the bankruptcy hierarchy.

No. It is near the bottom, in with unsecured debt. If you have access to the plan documents, see if the plan has the phrase "rabbi trust" anywhere in it. This means that the money is not kept comingled with the corporation's regular accounts, but is rather deposited with a financial institution (such as Fidelity).