the annual limit for my 401k is $500 - what can i do?

Question

Last year I was forced to take a withdrawal from my 401K because my company failed the highly compensated employee test. I had put in $18,000 into the 401K and got ~$10,000 back.

After that incident accounting set it up so that my 401K contributions would stop after $8k so that I wouldn't get a forced withdrawal again. But I just now got an email... they failed the highly compensated employee test again and now I'm getting $7,500 back. Which means that the most I can put into my 401K is $500, which is a joke.

If I understand https://www.hrblock.com/get-answers/taxes/personal-information/traditional-and-roth-ira-10769 correctly, I can't put money, tax-deferred, into an IRA, because my company has a 401K. However, if my company didn't offer a 401K I could.

It wasn't a huge issue when I was able to put in $8,000 into my 401K (which is still greater than the $5,500 IRA limit) but $500? I feel like I'm being screwed over. Everyone else gets to put in at least $5,500 towards their retirement, each year, tax deferred, and I can only do $500?

Do I have any recourse?

Answer 1

It's true that you can't put money, tax-deferred, into an IRA if your company provides a 401(k) and you exceed some income limits (see this IRS page). You may not be able to do anything about that this year.

You have two options, neither of which may be practical:

1. Find a new job - take a position at a company that doesn't fail the highly compensated employee test, and you'd be able to make your full contribution into a 401(k).
2. Scrap the 401(k) - you'd then be able to contribute to your IRA, tax-deferred
3. Help your company pass the test - talk to your HR department and do a few common things to pass the test. A couple things suggested by the IRS include:
   • Automatic enrollment - set up the 401(k) system so that all employees are enrolled (opt-out)
   • Increase the company match so employees would have an incentive to participate in the 401(k) program

I found a few links that include the tests that companies need to pass (see this page and this one). The easiest way (the Safe Harbor Match) requires your company to meet these criteria (see full page):

• Company matches 100% of all employee 401(k) contributions, up to 4% of their compensation, OR
• Company matches 100% of all employee 401(k) contributions up to 3% of their compensation, plus a 50% match of the next 2% of their compensation, OR
• Company contributes 3% of each employee’s compensation, regardless of whether the employee also makes contributions

However, this benefit change would increase the costs of the retirement program, which may lead your company to prefer option #2 (scrapping the program). A better case might be made by showing management how an improved program could have an impact on employee morale, retention, and recruitment, all linked to some figures about increased productivity.

Answer 2

There are a few ways you may still be able to contribute to an IRA.

1. Don't participate in the 401(k) plan. It is a common misunderstanding that if your employer offers a 401(k), that means you are covered by said plan. The IRS states that you are only covered if you actually participate in the plan. Participating meaning contributing yourself or having your employer contribute on your behalf. I suspect you aren't getting employer contributions, because if your employer was making contributions, they probably wouldn't have failed the HCE test.
2. Contribute (directly) to a Roth IRA. In 2018, if you had an AGI of less than $135,000 (single) or $199,000 (married) you can make at least a partial contribution directly to a Roth IRA.
3. Make a back-door Roth IRA contribution. Briefly: make a non-deductible contribution to a traditional IRA, then immediately convert it to a Roth IRA. This only works if you have no preexisting tax-deferred (i.e. deductible) traditional IRA funds, or if you are willing to pay the taxes to convert such funds to Roth as well.

Options 2 and 3 don't let you defer taxes this year, unfortunately. However, a Roth IRA is definitely better than nothing: you pay taxes this year, but don't have to pay them in the future. If the marginal tax rates (tax bracket) were the same this year and in the future year in which you withdraw, then mathematically, the two would actually be equivalent. In the real world, they aren't going to be exactly equivalent, but they'll generally be close enough that it's "good enough" to contribute to a Roth, especially if you don't have access to a tax-deferred account for whatever reasons.

Answer 3

You should tell your company to offer the same benefits to lower-wage employees so that you can receive the benefit that you agreed to in the contract you signed.