My boss told me I am on the verge of being considered a "Highly Compensated Employee" (HCE) and I need to aware of the HCE guidelines. He went on to tell me that every year in February HR performs 401k testing which determines at what salary level a HCE is defined and how much a HCE may contribute. What confuses me is he said that the testing, which will happen in February 2007 will determine how much a HCE will be able to contribute to their 401k in 2006. This seems grossly incorrect since it would obviously affect your taxes if the testing determined that a person could only contribute $2000 and they all ready contributed the maximum of $15,000. Not to mention one would receive a check for $13,000 in February that could have been invested otherwise. This may see trivial for someone well within the HCE guideline, but, a person living in an expensive area of the country, who just falls within the HCE guideline, and throw in a kid or two, it is much more than just a trivial matter. (It seems to me that one should be aware of being classified as an HCE and contribution limit before or early into the contribution year . . . for example the testing in February 2007 should be for HCE definition and contribution limits for 2007 using 2006 data.)
After searching the web, I realize there are different guidelines, including defaulting to a static salary threshold of $100,000 for 2006 and 2007, depending on the chosen 401k provider/plan. Is the $100,000 threshold a "floor" which the annual testing may not fall below?
It seems incorrect that a person who is nearing the HCE threshold could out-of-the-blue receive a letter and a check saying that the previous year they were defined as an HCE and here is a check with your excess contribution. Can anyone confirm and/or elaborate on that?
In my opinion, the standard/core investment strategies include a savings account at some short-term emergency level, max out your 401k, max out an IRA (roth if you fall above the deduction limits), sliding in purchasing a home at some point, and purchasing some life insurance at some point. If one suddenly becomes classified as an HCE, assuming minimal maintenance, where should one divert these funds? Are there alternative plans available? Or, is the next step opening up a brokerage account and buying mutual funds?
Thanks, BLC