401K HCI (Highly Compensated Individual)

[Jeffman52]

Well crap!! My wife just got notified that she is considered a HCI (Highly Compensated individual) from the IRS and as such she got kicked down to a low minimum on her 401K plan at MegaCorp. It can no longer be adjusted up, so we cant just let it ride and take it out later for a backdoor Roth.

So now I have to look into a new vehicle for retirement funds for her. What are your suggestions? We are still about 4 years out before we hit our financial targets to retire.

 

[FlaGator]

With that classification, she's probably not eligible for much of a Roth contribution or deductible Trad IRA, if any.

Low turnover index funds in a taxable account would be an option.

 

[OUTLAW]

Does she have any other programs available - HSA, 403, 457, TSP, etc?

 

[Jeffman52]

Does she have any other programs available - HSA, 403, 457, TSP, etc?

No such luck. Unless I figure something else out that is better, we will either invest in after tax mutual funds of some sort and I will increase my own 401K as much as possible to make up some of that ground.

 

[Scuba]

Too bad no alternative programs, but I strongly agree that funding a taxable account and investing there is very beneficial. Not only will it give you tax diversity in retirement, but there are no restrictions on accessing it. When we ER’d, over half of our overall portfolio was in a taxable account. It’s done very well and is now about 60% of our total portfolio.

 

[cathy63]

No such luck. Unless I figure something else out that is better, we will either invest in after tax mutual funds of some sort and I will increase my own 401K as much as possible to make up some of that ground.

She can make a non-deductible after-tax contribution to a tIRA account. If she doesn't already have pre-tax funds from previous 401K rollovers in a tIRA, then she can immediately convert that contribution to a Roth IRA.

Even if she has to leave it in the tIRA, it'll still grow tax deferred; you will just need to track the basis in that account on form 8606 when you file your tax returns so you don't pay tax on the contribution again when you withdraw it.

 

[Shanky]

Usually if there are options for folks who earn beyond ERISA maximums at publicly traded "Megacorps". SERP or Supplemental Executive Retirement Plans and Deferred Comp Programs usually fill the need for high compensated folks. 401 K max limits and matches are inadequate savings vehicles for someone earning $400K or $500K a year. One caveat, these programs are often not protected if the company goes into bankruptcy.

 

[Ronstar]

Well crap!! My wife just got notified that she is considered a HCI (Highly Compensated individual) from the IRS and as such she got kicked down to a low minimum on her 401K plan at MegaCorp. It can no longer be adjusted up, so we cant just let it ride and take it out later for a backdoor Roth.

So now I have to look into a new vehicle for retirement funds for her. What are your suggestions? We are still about 4 years out before we hit our financial targets to retire.

It happened to me several years in a row. It took me a while, but I finally convinced my minicorp partners to change to a "safe harbor" plan. The 'safe harbor' plan allowed the HCI's to max out their contributions, but cost the company more money to administer and also more $ in employer matches (even to those who did not contribute any of their earnings).

Not sure if 'safe harbor' plans still exist, but it may be something that your wife can explore.

 

[retire2020]

Too bad no alternative programs, but I strongly agree that funding a taxable account and investing there is very beneficial. Not only will it give you tax diversity in retirement, but there are no restrictions on accessing it. When we ER’d, over half of our overall portfolio was in a taxable account. It’s done very well and is now about 60% of our total portfolio.

+1. I've 2/3 in taxable and 1/3 in after tax. It'll help you BIG time if your are planning to retire earlier.

 

[Finance Dave]

She can make a non-deductible after-tax contribution to a tIRA account. If she doesn't already have pre-tax funds from previous 401K rollovers in a tIRA, then she can immediately convert that contribution to a Roth IRA.

Even if she has to leave it in the tIRA, it'll still grow tax deferred; you will just need to track the basis in that account on form 8606 when you file your tax returns so you don't pay tax on the contribution again when you withdraw it.

Bingo! This is what we did for about 8 years. Get some guidance, there are a few specifics you have to follow.

 

[cathy63]

Usually if there are options for folks who earn beyond ERISA maximums at publicly traded "Megacorps". SERP or Supplemental Executive Retirement Plans and Deferred Comp Programs usually fill the need for high compensated folks. 401 K max limits and matches are inadequate savings vehicles for someone earning $400K or $500K a year. One caveat, these programs are often not protected if the company goes into bankruptcy.

This is good info, but it's not quite what is happening to OP's wife. For 401K non-discrimination testing, employees who earn at least $120K (the threshold might be slightly higher now, but it's not anywhere near $400K) are HCEs. These employees can only contribute a percentage ratio that's 125% of what their lesser compensated colleagues contribute. So if the lower earners contribute on average 1% of their salaries, then the HCEs can only contribute 1.25% of theirs. There are several other ways to measure non-discrimination, but they all prevent HCEs from contributing the full $18K or $24K that the IRS would otherwise allow.

This is a big problem in tech startups, because there is a high proportion of HCEs, and the few employees who are not HCEs tend to be younger and working for very little and cannot afford to contribute much, if anything, to their 401Ks.

I got limited by this rule for years until we got bought by a medium sized corp that had lots more non-HCEs who were saving for retirement. This is why, despite my having earned about twice what DH earned for most of our working years, he ended up with about 33% more in his 401K.

 

[Shanky]

This is good info, but it's not quite what is happening to OP's wife. For 401K non-discrimination testing, employees who earn at least $120K (the threshold might be slightly higher now, but it's not anywhere near $400K) are HCEs. These employees can only contribute a percentage ratio that's 125% of what their lesser compensated colleagues contribute. So if the lower earners contribute on average 1% of their salaries, then the HCEs can only contribute 1.25% of theirs. There are several other ways to measure non-discrimination, but they all prevent HCEs from contributing the full $18K or $24K that the IRS would otherwise allow.

This is a big problem in tech startups, because there is a high proportion of HCEs, and the few employees who are not HCEs tend to be younger and working for very little and cannot afford to contribute much, if anything, to their 401Ks.

I got limited by this rule for years until we got bought by a medium sized corp that had lots more non-HCEs who were saving for retirement. This is why, despite my having earned about twice what DH earned for most of our working years, he ended up with about 33% more in his 401K.

Thanks for clarifying. I was thinking a a "Rabbi Trust" set-up which "mimics" a 401k set-up by deferring income. I believe this usually applies to incomes beyond the 270-280K range. It would seem if the OP's 401K Contribution is limited because of the aforementioned rules, something like this should be able to be used. If not, some other form of deferred income such as equity grants might work if they can be deferred until retirement.

 

[Jeffman52]

This is good info, but it's not quite what is happening to OP's wife. For 401K non-discrimination testing, employees who earn at least $120K (the threshold might be slightly higher now, but it's not anywhere near $400K) are HCEs. These employees can only contribute a percentage ratio that's 125% of what their lesser compensated colleagues contribute. So if the lower earners contribute on average 1% of their salaries, then the HCEs can only contribute 1.25% of theirs. There are several other ways to measure non-discrimination, but they all prevent HCEs from contributing the full $18K or $24K that the IRS would otherwise allow.

This is exactly right!!! The suggestion from HR was "Talk up 401K with the lower paid employees."

 

[Jeffman52]

Too bad no alternative programs, but I strongly agree that funding a taxable account and investing there is very beneficial. Not only will it give you tax diversity in retirement, but there are no restrictions on accessing it. When we ER’d, over half of our overall portfolio was in a taxable account. It’s done very well and is now about 60% of our total portfolio.

The more I think about it, the more I like this idea. My wife and I are heavy into before tax retirement accounts. It will make sense to diversify more. I will make some calls (maybe call Fidelity) and see if I can find something that makes sense for us.

 

[Out of Steam]

This is exactly right!!! The suggestion from HR was "Talk up 401K with the lower paid employees."

This is actually one of the reasons why 401k matches are common. Basically, companies pay the rank-and-file to contribute more so that management's contributions aren't limited.

 

[growerVon]

When looking at securities to hold in taxable accounts, this boglehead page can be helpful: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

 

[growing_older]

Depending on the size of the company, you can also lobby for the 401k plan to be made a "safe harbor" plan, which exempts it from the HCE test.

 

[bUU]

I did a couple of years ago.

I was ignored.

Hmph.

 

[Surewhitey]

This is good info, but it's not quite what is happening to OP's wife. For 401K non-discrimination testing, employees who earn at least $120K (the threshold might be slightly higher now, but it's not anywhere near $400K) are HCEs. These employees can only contribute a percentage ratio that's 125% of what their lesser compensated colleagues contribute. So if the lower earners contribute on average 1% of their salaries, then the HCEs can only contribute 1.25% of theirs. There are several other ways to measure non-discrimination, but they all prevent HCEs from contributing the full $18K or $24K that the IRS would otherwise allow.

This is a big problem in tech startups, because there is a high proportion of HCEs, and the few employees who are not HCEs tend to be younger and working for very little and cannot afford to contribute much, if anything, to their 401Ks.

I got limited by this rule for years until we got bought by a medium sized corp that had lots more non-HCEs who were saving for retirement. This is why, despite my having earned about twice what DH earned for most of our working years, he ended up with about 33% more in his 401K.

+1 on the $$ threshold. DW use to qualify, then the $$ went "slightly" up and she didn't qualify. She got 2 years into the account (50% of her pay). On year 3 they said the amount actually went past her amount the year before and forced her to "pay it back". We fought it tooth and nail (and lost) Got a big ole tax bill that year. She had an option of taking it in a lump, 5 year or 10 year payout. She picked 5 years and we lived on that in Mexico for some years.

The wages were earned in CA, so when we moved to TX, we got 100% refund in CA for the taxes withheld on a state level (no income tax in TX). Worked out perfectly as this would have been taxed appx. 43% (fed & state) if we didn't "do it". The eventual tax in TX put us in the 10-15% rate for the 5 years of payouts. It's a very good way to lower taxes for sure.