Ask the Expert

By: Ted Benna   Creator of the first 401(k) plan

January 22, 2002


This Week, Ted Tackles:

Can you explain how the age-50 catch-up contribution limit works? ... I earn overtime and my salary fluctuates. If I max out my contributions early in the year, I miss out on part of my employer match. How can I set my contributions so I get the full match? Are vacation and severance pay subject to 401(k) deductions? I change jobs frequently and often miss vesting my employer match. Can my employers boost the amount I can contribute to make up for that loss?

Q: We are confused about the $1,000 catch-up contribution for employees who are at least 50 years old. We have heard two different things: 1) you can contribute an extra $1,000 over the 15 percent limit on our plan, which would be a separate payroll deduction with no employer match, or 2) the catch-up contribution increases your yearly maximum contributions to $12,000 but you could still be limited to the standard maximum of 15 percent. Please help us sort out this confusion.

TB: First, the catch-up contribution may be made only if the plan document is amended to permit this contribution. If you are the employer, you must amend the document. If you are an employee, you must wait for your employer to amend the document. I'm going to assume you are an employer asking this question.

Second, there isn't any more reason for you, as the employer, to restrict employee contributions to only 15 percent of pay. The maximum combined employee/employer percentage has increased from 25 percent of pay to 100 percent of pay for plan years beginning after Dec. 31, 2001. I recommend employers increase the maximum employee contribution percentage to at least 75 percent.

The catch-up contribution can be made only after all other limits have been hit. Assume you earn $50,000, your plan retains the 15 percent limit and the plan is amended to add the catch-up contribution. The maximum amount you may contribute is 15 percent of $50,000, which is $7,500, plus the $1,000 catch-up contribution -- a total of $8,500.

If the plan is also amended to raise the maximum individual contribution percentage to 75 percent, you may contribute $11,000 plus the $1,000 catch-up contribution -- a total of $12,000.

Bottom line, the law has been changed permitting employees to contribute a much higher percentage of pay plus the catch-up contribution if they are at least age 50. Let me reiterate, the plan must be amended before employees can take advantage of these changes.

Unfortunately, I am finding other employers share your confusion. I visited the CFO of a company on Jan. 5 who told me his service provider hadn't told him anything about these changes. His service representative said things are still being finalized. That's wrong. In the fall of 2001, the IRS issued model amendments (which can be found on the IRS Web site at www.irs.gov) for implementing these changes. You should have received these amendments from your provider by now, at least. Get after them if you haven't.

Q: My employer matches my 401(k) contributions at a rate of 50 cents on the dollar, up to 10 percent of salary. For 2002, I changed my contribution to 25 percent of my salary to help me reach the $11,000 limit. I get overtime pay, which could result in my hitting the limit before year-end. My problem is this: my employer says that if I contribute too much early in the year I could reach my limit and lose out on my employer match for the rest of the year. I would like to contribute a flat weekly amount to prevent this, but my employer says I must commit to a percentage-of-pay amount and change it accordingly throughout the year. How can I do this easily?

TB: As I see it, you have two goals -- to contribute the maximum $11,000 amount and to receive the maximum matching employer contribution.

I recommend establishing your contribution rate by dividing $11,000 by the total amount you expect to earn (base and overtime) during 2002. Assume your base pay is $50,000 and you expect to earn $10,000 of overtime. You will have to contribute 18.3 percent of your pay to hit the $11,000 maximum. Your employer, like most employers, requires you to contribute an even percentage of pay. Contribute either 18 or 19 percent.

Assuming you are permitted to adjust your percentage at any time, you should review the results at mid-year, on Sept. 30, and during December to see whether adjustments are necessary. For example, if you have worked a lot less overtime during the first six months than you expected, increase your contribution percentage for the rest of the year. Make any final adjustment in early December. This procedure should enable you to get close to hitting both goals.

This problem occurs with plans where the employer matches employee contributions only during periods when the employee is contributing rather than determining the match based on the percentage of an employee's annual pay that is contributed, no matter when it is contributed.

Q: Are vacation and severance pay subject to 401(k) deductions when an employee terminates employment?

TB: Yes, concerning vacation, and no, concerning severance. It's my understanding that deductions should not be made from severance pay because the participant is no longer an active employee.

Deductions are normally made from vacation pay because this is compensation earned for the performance of services.

There are many definitions of compensation that may be used for plan purposes, and different compensation may be used for different plan purposes. For example, the compensation used for contributions may be different than the compensation used for compliance testing. It is necessary to follow the applicable definition that is included in the plan document.

I recommend you take a look at your copy of your summary plan description for the rules governing your plan.

Q: I've worked for a Fortune 50 company for a little over a year. I have changed jobs frequently in the past and anticipate doing so in the future to increase my compensation more quickly. My issue, of course, is losing any employer-matching contribution. Is there any reason why I shouldn't be able to opt out of the matching contribution if I could contribute a higher percentage of my own compensation? This is what I'd like to do.

TB: The provisions of your plan generally must apply uniformly to all employees. There are exceptions, particularly with respect to highly compensated employees. For example, your employer could amend the plan to exclude you from receiving the matching contribution if you are a highly compensated employee. However, you probably won't be permitted to increase the amount you contribute because this will reduce the amount that one or more of the other highly compensated employees may contribute.

Most employers of this size have nonqualified savings plans, which permit eligible highly compensated employees to defer taxes on a larger percentage of pay than is permitted with the 401(k). You may want to check with your employer to see whether it has such a plan.

You should also be aware that the vesting rules for matching contributions have changed for plan years commencing after Dec. 31, 2001. Plans with cliff vesting schedules, meaning you get the money all at once after working for a certain period of time, are required to vest employer contributions in three years or less. Plans with graded vesting, meaning a portion of the employer's contribution becomes yours each year, must vest fully within six years. This may increase the likelihood that you will work at an employer long enough to get at least some of the match.

 

Ted Benna Ted Benna, creator of the first 401(k) retirement savings plan, answers intriguing questions twice a month. With over 40 years of experience as an employee benefits consultant, Ted is a nationally recognized expert on benefits issues. He has authored three books, Helping Employees Achieve Retirement Income Security, Escaping the Coming Retirement Crisis, and Tips for Successfully Managing Your 401(k), and is President of the 401(k) Association. Ted is a frequent speaker at meetings of 401(k) plan sponsors and participants. His articles and comments have appeared in numerous publications, including The New York Times and The Wall Street Journal.

Ted's Table Archives 


The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

mPower.com is the premier online community resource for 401(k) participants
Copyright 1996 - 2000 mPower. All Rights Reserved.

 

Section Guide | Feature Articles | The Experts | 401(k) ABC's

Wall Street 101 | The Bear's Cave | 401(k) Frequently Asked Questions | Retirement Calculator