Unwanted Distribution from 401k

[FrugalRubles]

I work at a company of under 75 full time employees. I maxed out my 401k the last few years. I just got this email from our head of HR, informing me that I would be receiving a check for $3k.

Please keep in mind that I do not receive any employer match, I contributed all funds. Has anyone ever seen this?

The Internal Revenue Code limits the maximum amount of employee elective deferrals, after-tax and employer matching contributions that may be credited to your account in any one plan year. The limitations are determined by performing certain tests known as the Actual Deferral Percentage ('ADP') test and the Actual Contribution Percentage ('ACP') test, which compare the contribution percentage of the highly compensated employees (the'HCEs') to the non-highly compensated employees (the 'NHCEs'). If the difference between the HCEs and the NHCEs percentage exceeds the maximum allowable percentage, excess contributions (employee elective deferrals) or excess aggregate (after-tax/matching) contributions, must be removed from the participant's accounts.

Based on the results of the ADP/ACP testing performed for your plan, you were determined to be a highly compensated employee who received contributions in excess of the permitted limits. Therefore, your plan administrator has instructed Voya to make a corrective distribution of your excess contributions and/or excess aggregate contributions. Any gain associated with these excesses must also be distributed.

The amount of this corrective distribution must be reported as income in the year distributed to you. Note that any portion of the refund which represents employee after-tax contributions or designated Roth contributions (if applicable) is not taxable; however, the earnings associated with those contributions must be reported as income. We also urge you to retain a copy of this confirmation with your tax records and consult your tax advisor to determine tax treatment of this transaction.

[msilenus]

I've heard of it.  Your employer failed the non-discrimination test, which means the plan is being deemed to be excessively beneficial to highly compensated employees, relative to non-HCEs.  The test is based on employee behavior.

It's a weird test.  If you can persuade your lower-earning colleagues to contribute more, you'll be able to contribute more without getting these distributions.

There is also a safe harbor.  If your employer adopts a fairly specific matching structure, there will be no discrimination testing.

[FrugalRubles]

I've heard of it.  Your employer failed the non-discrimination test, which means the plan is being deemed to be excessively beneficial to highly compensated employees, relative to non-HCEs.  The test is based on employee behavior.

It's a weird test.  If you can persuade your lower-earning colleagues to contribute more, you'll be able to contribute more without getting these distributions.

There is also a safe harbor.  If your employer adopts a fairly specific matching structure, there will be no discrimination testing.

Thank you. They have no intention of providing any 401k match, but I didn't realize I could see my contributions refunded / tax benefits reduced. Pretty shitty. I offered to hold a session for the 401k for our employees, but they said they would set up one via the plan administrator (who couldn't answer any of my questions and gave me their hotline).

[Need2Save]

FrugalRubles - this happens more than people know and please don't blame your Company or HR person.  It is far more common at a smaller company because if the plan provides more benefits to the highly-compensated employees than the non-highly compensated employees, the IRS requires that the Company 'even things out' so to speak.  To do this, they start with the highest earner and work their way down.  It royally sucks.  The only thing you can suggest to your HR person is that they take a more active approach to encourage ALL employees to contribute this year to decrease the chances it will happen again. Or consider adopting a 'Safe Harbor' Plan such as suggested by msilenus.   This is an up-hill battle since your employer doesn't offer any kind of incentive like a match and doesn't plan to.  You just have to hope that all your coworkers see the wisdom in saving for their future selves.   If you aren't getting a match, maybe this will effect the decision of where to put your retirement money going forward?

Employers have to run all kinds of tests like this that make absolutely zero sense to anyone.  I'm in the business and I still find that the outcome of the tests do not achieve the results that the IRS believes it will.  Similar Non-Discrimination Testing (dictated by the DOL and IRS) can effect the amount of FSA money a Highly Compensated Person can contribute in a year and can also effect the Health Plan as well.  At my company, we haven't yet failed the 401k tests, but we have failed the FSA test in previous years and had to limit the amount that employees can put towards dependent day care.  Like a company can predict how many employees will be having kids and how many will want/need to put those kids into day care under the age of 13!?! 

[newton]

It happens to be every year.  Every year I complain.  My company said they would do a better job of promoting the 401K to employees but they really haven't.  Nothing you can do about it.  It sucks when you get penalized (or not being able to take full advantage of) for doing the right thing.  I'm not able to save in a 401K like I want.  I try and max out a Roth and then every April use this return as a bonus.

You will get something in the mail that you have to use when you do your taxes the next year.  Make sure you keep that document.  It shows the distribution.

[FrugalRubles]

FrugalRubles - this happens more than people know and please don't blame your Company or HR person.  It is far more common at a smaller company because if the plan provides more benefits to the highly-compensated employees than the non-highly compensated employees, the IRS requires that the Company 'even things out' so to speak.  To do this, they start with the highest earner and work their way down.  It royally sucks.  The only thing you can suggest to your HR person is that they take a more active approach to encourage ALL employees to contribute this year to decrease the chances it will happen again. Or consider adopting a 'Safe Harbor' Plan such as suggested by msilenus.   This is an up-hill battle since your employer doesn't offer any kind of incentive like a match and doesn't plan to.  You just have to hope that all your coworkers see the wisdom in saving for their future selves.   If you aren't getting a match, maybe this will effect the decision of where to put your retirement money going forward?

Employers have to run all kinds of tests like this that make absolutely zero sense to anyone.  I'm in the business and I still find that the outcome of the tests do not achieve the results that the IRS believes it will.  Similar Non-Discrimination Testing (dictated by the DOL and IRS) can effect the amount of FSA money a Highly Compensated Person can contribute in a year and can also effect the Health Plan as well.  At my company, we haven't yet failed the 401k tests, but we have failed the FSA test in previous years and had to limit the amount that employees can put towards dependent day care.  Like a company can predict how many employees will be having kids and how many will want/need to put those kids into day care under the age of 13!?! 

Thanks. I do my best not to complain, this is the first year it affected me. I speak to my team about taking responsibility for their retirement, but most are not very mustachian. As you mention, there aren't any additional benefits for highly compensated employees, it's just that more of us make take advantage of them. Is this discrimination testing based on the overall plan totals or just based on annual contributions? We have some turnover with lower level employees, so I could see this becoming a bigger issue if management and more senior / highly compensated employees remain. It just feels like the IRS doesn't do enough to assist those that want to save for retirement, especially if they assume most employees won't take advantage of Roth Conversion ladders and the like, which would keep the funds invested. I don't yet have any kids, but the FSA sounds even worse. Thanks for the info.

It happens to be every year.  Every year I complain.  My company said they would do a better job of promoting the 401K to employees but they really haven't.  Nothing you can do about it.  It sucks when you get penalized (or not being able to take full advantage of) for doing the right thing.  I'm not able to save in a 401K like I want.  I try and max out a Roth and then every April use this return as a bonus.

You will get something in the mail that you have to use when you do your taxes the next year.  Make sure you keep that document.  It shows the distribution.

Thanks. I do max out the Roth as well, but not many other options beyond that (with no kids, no access to HDHP, etc.). First class problems, for sure, but I didn't realize my company could actually have a negative impact on my options.

[Need2Save]

I guess, what I should have said is "you have the right to be disappointed, but instead of just being angry at HR or the top-boss, you should ask if there is a constructive way that the company can pull-together to avoid this happening again next year."  You didn't indicate where you are with respect to being one of the top earners in the company, but you can believe that if they had to return some $ to you, they did so as well to everyone who makes more $ than you (assuming they all contributed).   You should suggest they bring in someone to talk with the entire staff about retirement planning.  The recordkeeper from your 401k plan should be able to do so for free, and provide the absolute basic fundamentals of compounding interest and annual contributions limits, etc.    If you are confident enough in your own skills - maybe you can volunteer to host an informal lunch-n-learn on the topic.  Have the company offer to buy lunch.  If HR is not okay with that, they should at least be willing to bring in a professional. 

There are two 401(k) tests - one for overall contribution levels (% of those who actively participate) and one for the average deferral rates (percentages of actual $ contributions).  The HCEs and the NHCEs cannot be more than 2% apart from one another when you average it out.    So, for example if all the HCEs put in an average of 8% and the NHCEs put in an average of 3% - you have a 5% difference and this is way more than the 2% allowed by ERISA, this a testing failure and you have to return some of the HCE contributions to bring it to within 2% of the NHCEs unless you have one of those Safe Harbor plans.