A 401k 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 401k plan as permitted by the IRS. If they are age 50 or older, they may be able to contribute as much as $60,000 (for 2018). Some highly compensated individuals are unable to maximize their contributions, however, if lower paid workers are not saving aggressively in their 401k plan.
You are considered a “highly compensated employee” for 401k plan purposes if you earn $120,000 or more per year or own more than 5% of the company.
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 401k. Fortunately, there are still plenty of methods for high earners to save for retirement.
Almost all 401k plans accept “catch-up contributions.” Catch-up contributions are salary deferral contributions made by business owners and employees who are age 50 or older. An additional salary deferral of up to $6,000 can be made as a catch-up contribution on top of the maximum annual salary deferral ($18,500 for 2018).
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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 401k plan are not making significant contributions. 401k plans must pass certain nondiscrimination tests each year to demonstrate that the plan is not discriminating against lower compensated employees.
These tests limit the:
If a 401k 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.
To prevent disproportionately large contributions for HCEs, the 401k plan rules place a limit on the amount of compensation that may be considered when calculating an employer matching contribution or other contribution that is based on a percentage of compensation.
For 2018, this limit is $275,000.
For example, assume you earn $300,000 for 2018. The 401k 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 $8,250 (3% x the compensation cap of $275,000) – not $9,000 (3% x your full compensation of $300,000).
Business owners and HCEs may be able to increase the amount they can contribute to a 401k plan through one or more of these strategies.
Catch-up contributions are made after an individual reaches the $18,500 (for 2018) 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 $18,500 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.
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 401k, business owners may want to engage financial advisors or other service providers to educate employees about the benefits of saving in a 401k 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 401k 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 401k plan may also help improve participation and savings rates for all employees.
If you’re a small business owner and need a 401k plan for yourself and your company, only Ubiquity offers flat-fee plans plus free expert advice. We’ll fully customize your 401k to meet the specific needs of your small business.
Setting up a 401k can be complicated. Only Ubiquity gives small business owners access to 401k experts in addition to industry leading low flat-fees. Each sales expert has over a decade of experience assisting business owners in 401k plan design. Take advantage of this free benefit.
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