Maxing 402(g) Limit Early in Year

[Guest kjk]

Is there anything (besides a plan term) to prevent a highly compensated employee from maxing-out the 402(g) limit in his/her first month of employment?

[Fredman]

I'll save pax the trouble: What does the document say?

Some things to check:

Has the HCE met the eligibility requirements of the plan?

And if so, have they passed an entry date?

Does the plan have a deferral limit, based on percent of pay that is payroll by payroll specific?

Does HCE have enough comp in their first month to defer this much?

I've seen situations where an HCE will put in 402g limit during the first payroll of the year, so its possible, but make sure you don't break any plan rules along the way.

[Guest kjk]

Thanks a lot. This was a hypothetical question. I have been asked by an employer whether such action (making the max deferral in the first month of the year) would be somehow discriminatory to those participants who can't afford to make such an election, etc. I hadn't found anything in the Code or regs. to prevent a participant from making such a large deferral (unless, as you point out, the plan would somehow prohibit it), but I just thought I'd bounce the question off you folks! Thanks again.

[mbozek]

Why is this issue any different from the situation where a plan participant makes the 402(g) contribution in the last month of the plan year by forgoing salary or by using a year end bonus.

The only posssible restriction is if the plan doucment limits the amount each of payroll that an employee can contribute to the plan instead of an aggregate annual limit. Also employer must withhold fica tax, loan payments and Sect 125 contributions.

[Guest kjk]

I guess the difference is that the person who contributes the full amount in January gets to enjoy the next 11 months of being invested in the market (and hopefully making money); whereas the person who contributes at the end of the year does not get that extra time. However, you make a good point as to the larger issue (i.e., whether or not you can make the large, lump sum deferral in the first place). Thanks for your reply.

[mbozek]

I dont know of any regulation that ascribes discriminatory conduct to the timing of early contributions in a tax year-- the IRS regs only prohibit discriminatory action with regard to the amount of contributions. All of the investment advice I have reviewed encourages employees to make their 401(k) contributions as quickly as they can for the very reason you mention.

[Appleby]

The plan in which I participate allows participants to max out at the beginning of the year. This is a very large plan, which is administered by a reputable and competent administrator, ; therefore I have no reason to doubt the legitimacy of this permission.

[wmyer]

I agree that it is okay to do this. However, if the plan has a matching formula and it applies the match on a payroll-period basis, the HCE may be missing out on potential matching contributions.

[Guest Tom Geer]

There is a very old, but post-ERISA ruling that says that differences in timing of contributions can cause discrimination in operations. I can't find it right now, but I know it exists.

Also, I would be nervous about whether the nondicsriminatory availability Regs. (1.401(a)(4)-4). The Reg is taking forever to retrieve, so I'll follow up with sepcifics on it once it's here.

Neither of these means you can't do it. I would just be very careful to give the same rights to HCEs and NHCEs.

[stephen]

It may not be prudent to make a $11,000 contribution in January. For long term investing wouldn't the participant be better off dollar cost averaging their contributions throughout the year?

[mbozek]

It depends on what the money is invested in and what will happen in the next 12 months. If the employee puts it into a fixed fund earning a rate of 6-8% then it would be to the employees advantage to put the money it as soon as possible. If the funds are invested in equities then it depends on whether the market goes up or down in the next 12 months. If it goes up dramatically then it would be good to invest the funds earlier rather than later. If the market is going to go down then dollar cost averaging would be the right approach.

[Guest Giovanni]

wmyer makes a very good point. If your Plan says that the match is calculated on a payroll by payroll basis, and the match is based on a percentage of comp, an employee will lose out on getting the maximum match available under the Plan. I would suggest the employee evenly contribute throughout the year ($11,000/# of payrolls).

If the Plan says the match is calculated on an annual basis, the Employer can make a true-up contribution for the employee after the end of the year. This way the employee will be made whole.