I know that the IRS has certain compliance rules for 401(k) plans, e.g., to make sure that the plans aren't mainly for the benefit of highly compensated employees. Here's a summary of the rules:
http://www.cpas-401k.com/401k-compliance-testing-rules.html
Is it possible that the companies imposing say a 20% cap do so to make sure they comply with the IRS rules?
This is the reason we were given as to why we were limited to 16% and then 20%. The non-highly compensated employees weren't contributing enough and it looked like another "perk" only for the highly compensated employees.
Joggernot, I think your company's management is confused.
If the NHCE's contribute an average of 7%, the HCE's can contribute an up to 9% or so. If they put a limit of 20% in place they are potentially limiting their own contribution rate.
Example with 10 NHCE's and a 75% wage contribution limit:
Wages Rate Contr.
1 50,000 0% -
2 50,000 0% -
3 50,000 0% -
4 50,000 0% -
5 50,000 0% -
6 50,000 0% -
7 50,000 0% -
8 50,000 0% -
9 50,000 35% 17,500
10 50,000 35% 17,500
Tot 500,000 70% 35,000
Avg 50,000 7% 7.00%
You have 10 employees. All of them make $50K. 8 of them "can't afford" to contribute to a 401K. 2 of them are mustachians and want to max out. In this scenario they can, and HCE's can contribute around 9% or so of their own wages. $17,500 / 9% = $194,444 in wages.
Now let's use your company's arbitrary 20% contribution limit and see what happens:
Wages Rate Contr.
1 50,000 0% -
2 50,000 0% -
3 50,000 0% -
4 50,000 0% -
5 50,000 0% -
6 50,000 0% -
7 50,000 0% -
8 50,000 0% -
9 50,000 20% 10,000
10 50,000 20% 10,000
Tot 500,000 40% 20,000
Avg 50,000 4% 4.00%
Because of the 20% limit, the average NHCE contribution is now 4%, so the maximum HCE contribution is about 6%. $17,500 / 6% = $291,667 in wages.
They are not only screwing the 2 smart people who want to max out by $7,500, but they also now have to earn $100K more in wages just so they can max out. I don't see how this helps anyone.