Highly Compensated Retirement Contribution Options

by Andy Hough on January 2, 2007

When you’re a “highly compensated employee,” you’re limited in how much you’re allowed to contribute to your 401(k). You are limited because the government wants the playing field to be level and it’s “unfair” to lower compensated employees if more highly compensated employees contributions outstrip the percentage for the lower compensated employees. Whether or not it’s unfair is another issue but reality is reality. So, what is a highly compensated employee to do?

Contribute to an Individual Retirement Arrangement (IRA) instead. While you won’t be able to get an employer match on the money, you will be able to defer the taxes on the income until you actually retire. Traditional IRA’s are usually not a good idea for those of use who aren’t highly compensated because we are usually still eligible for a full contribution to Roth IRA and the contribution limits are shared by both. For example, if you contribute $1,000 to a Traditional IRA, then that’s $1,000 you cannot contribute to your Roth IRA because they share limits. However, if you are highly compensated, you are likely in the Roth IRA contribution phaseout range and so at least a partial contribution to a Traditional, whatever you can’t contribute to your Roth, makes sense because you can at least get some tax relief, since one is available by way of the 401K.

(This argument only applies for those who are classified as a highly compensated employee on an income basis, not on an equity basis)

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