Why DH’s retirement account sent us a check for >$3000

Shortly after DH’s company switched from a high cost retirement provider to Fidelity (which is a better choice for small companies than is Vanguard because Vanguard charges small companies pretty high fees, in case you were wondering), DH got a check in the mail from Fidelity for >$5K.  As a distribution.  Even though DH is well under any possible age for required distributions.

It wasn’t a mistake.

On the back of the statement, it said, “It has been determined that you had an excess contribution…due to your plans non-discrimination testing…”

The problem, as explained to DH by the company’s finance person and also in this post I found online is that DH’s company doesn’t compensate its less highly employees as well for retirement as it does its highly paid employees.  And the highly paid employees are contributing to retirement compared to the less highly paid employees in too high a ratio.  So they failed a non-discrimination test and send money back to highly paid employees so that the overall firm level of contribution no longer fails that test.  It is our understanding that we will pay taxes on that money as if it is income in the 2017 tax year (though it is income from 2016).

So, DH can’t put away the full 18K + employer match (which is going away for the foreseeable future anyway) each year for retirement, but some number less than that.  So it’s a good thing that I can put away large amounts in my university 403bs and 457 plans.

There is a way to make it so the company doesn’t have to pass the non-discrimination testing, but figuring that out and pushing for it didn’t seem worth looking into given the way that DH’s company is laying everybody off at the end of the month.

So, that’s one of the fun things about working for a small company.

Have you ever gotten a 401(k) distribution because your company didn’t pass non-discrimination testing?

24 Responses to “Why DH’s retirement account sent us a check for >$3000”

  1. Taylor Lee @ Yuppie Millennial Says:

    My company has a safe harbor 401k (minimum match requirements /automatic employer contributions) that allows them to get around this issue. When we were a small company (25 people), they didn’t do 401k at all and our employer just contributed a big chunk (15% of income) to SEP IRAs automatically without us needing to put in a match, which was *awesome*.

    • nicoleandmaggie Says:

      That does sound awesome.

      I think DH’s company needs the flexibility to stop offering the match benefit. My uni requires us to put away a certain % which they match automatically (so we end up having something a little over 10% of our income automatically saved once you include the match as income). This seems like a good thing to me even if it means less freedom.

    • Kellen Says:

      Yeah, this is “the way” you guys mention in the blog post to make it so the company doesn’t have to go through the test. It’s not super complicated, but the company has to either:
      a) Essentially have a 4% match (so if an employee contributes 0% of their paycheck, the company still doesn’t give them anything)
      b) Contribute 3% of employee’s salary (NOT a match, so if an employee contributes 0% of their paycheck, the company still puts an additional 3% to the employee’s 401(k).)


  2. bogart Says:

    That has not happened to me/us, no. Five or 10 years ago, my current employer (large) started making its retirement contribution (the employer portion) to all employees’ accounts, regardless of whether we contribute or not, which (a) is nice and (b) as I understand it, resulted from this rule, i.e., low-paid employees weren’t contributing/receiving enough for highly paid employees to be able to contribute as much as they wanted.

    • nicoleandmaggie Says:

      That would have been a nice solution… alas, the company is out of money until July.

      • bogart Says:

        Indeed — clearly not workable in your case. Workable here partly, obviously, because it’s possible but also because there’s clearly an interest in hiring and retaining very highly paid people who care about such things.

  3. Linda Says:

    I haven’t run into that. I work for a pretty big company, though, so that may be why.

    As for your contributions, are you saying that you can contribute more than $18k a year to your combined retirement accounts? If so, that is an awesome benefit. This year I’m eligible for catch up contributions (one benefit of turning 50, woo hoo), but I haven’t decided if I’ll do that yet. I’m not sure I’d want to reduce my take home pay since I have higher housing costs now that I did back in Chicago.

    I guess the upside is that you’re getting this distribution in a tax year where he will have less income overall, right?

    • nicoleandmaggie Says:

      I can contribute: ~6% of my salary (required contribution and there’s a match) + 18K for the 403b + 18K for the 457.

      Yes, he should have less income overall, and the check is coming at a good time in terms of cash flow.

  4. Leigh Says:

    I know one of my previous employers had this problem but I wasn’t ever affected by it. Similar to your husband’s plan, it wasn’t a safe harbor one. My other employer was very careful about maintaining their safe harbor status.

    I wonder if your husband’s plan having such high fees and no match deters people from contributing to it and in turn creates this problem, an unfortunate double whammy of a small employer. At least they have a 401(k) I suppose.

  5. crone Says:

    The company OUGHT to have done mid-year testing to ensure this would not happen. And, made adjustments as necessary at that time. But, oh yes, this happens. Can you still do a ROTH for him as it is pre April Tax day?

    • nicoleandmaggie Says:

      We could do a backdoor Roth IRA for him, but it’s not really worth it since I’m already maxing out my retirement… we haven’t been able to contribute to a regular Roth IRA since he got this job.

  6. Revanche @ A Gai Shan Life Says:

    No, unfortunately dealing with any questions like that is why my small company doesn’t offer any retirement plans at all :( I’m getting tired of working for companies that don’t have any retirement plans. I don’t make enough extra money on the side to justify setting up my own SIMPLE or SEP IRA but I’m so annoyed it may become a priority solely so I can start socking away real money for retirement.

  7. Leigh Says:

    There are a bunch of threads on this right now on Bogleheads. I found this example really helpful to understand after reading it a couple times: https://www.bogleheads.org/forum/viewtopic.php?f=2&t=213702&newpost=3282431#p3282386

  8. Angela Says:

    The first company I worked for put money into my retirement account without me making any contributions to avoid failing this test. I only worked there one year, so I don’t know if it was a regular occurrence (and I wised up and started contributing for my own retirement in my second job!)

  9. Kellen Says:

    So, our company is subject to non-discrimination testing, and I’m not familiar with all the tests, but I’m pretty sure I personally am making it significantly less likely that we would fail the test, since I contribute 25% of my income and I am *not* an HCE. We have a couple of other big savers too, which makes up for having several other employees who don’t contribute at all. So if DH’s company is small, maybe the solution is to hire a bunch of people from the FIRE community and don’t pay them enough to be HCEs? ;)

    A more serious recommendation: I commented about the “safe harbor” method above, which it sounds like DH’s company can’t do. They other approach is to get the company to “promote” the 401(k) plan such that more non-HCEs participate in the plan.
    Common ways to do this:
    1) Make sure you remind employees that the plan exists, perhaps through an annual meeting to educate them on 401(k) plans, and if there is at least a small company match, to explain the benefit of contributing to get that match.
    2) It is allowed to set up your 401(k) plan such that new employees are automatically set up with a salary deduction of x%. They can then change that to 0%, but the same laziness that prevents people from setting up a contribution in the first place might slow them down from changing the contribution down to 0%.

    • nicoleandmaggie Says:

      We think there are only two non-HCEs in the company: the grantwriter and the woman in charge of finances.

      Right now the company can’t do much of anything because it is out of cash until July when a grant turns on.

  10. Leigh Says:

    Hey look it’s almost exactly a year later. My husband just got an email that he is going to get such a check. I guess we should get the check soon, at which point we will know how much it is. I wish his employer would fix their plan. They’re not a small company – they are beyond large enough that they should fix their plan.

    • nicoleandmaggie Says:

      We still haven’t heard for this year. The company laid off the grantwriter, but they still have the woman who does finances.

    • nicoleandmaggie Says:

      Just got ours again– more than 3K again. Oh well, at least we did the backdoor Roths this year. Given that we’re a bit cash poor at the moment from having bought that car, I can’t complain too much.

      • Leigh Says:

        Yeah it was just north of $3000 and then they took taxes out, so it was a little under it. He deposited it into his taxable account, including making up the taxes. I’m glad I did the Mega Backdoor Roth IRA those two years! The bonkers thing is that at his company, fresh-out-of-college level employees are at the HCE level of income.

  11. obnoxious ramblings on income, unearned income, taxes, and so on | Grumpy Rumblings (of the formerly untenured) Says:

    […] It turned out DH had not paid any attention to the fact that we put tax-free (for now) money into a required retirement fund (6% of my income), a 403(b), a 457, and as much of a 401K as DH’s non-discriminating test failing fund will allow. […]

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