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It's All About The Catch-Up!

It's All About The Catch-Up!

June 25, 2021

Catch-up not Ketchup!

One time, I was doing a 401k plan review meeting and I talked about the catch- up provision.  Being from Roswell, N.M., I have a bit of an accent and the people in the meeting thought I said, ketchup.  As I was talking, I noticed they all had a rather strange look on their face, so I asked them what was going on.  They said, ketchup provision???  No!  Catch-Up.  Like catch a ball and look up.  Oh, that makes sense and on we went.  Being an experienced person (over the age of 50), I thought it would be a good idea to talk about this.

What is a Catch-Up Contribution?


Here’s a definition I found on the internet.  A catch-up contribution is a type of retirement savings contribution that allows people aged 50 or older to make additional contributions to 401(k) accounts and individual retirement accounts (IRAs).  When a catch-up contribution is made, the total contribution will be larger than the standard contribution limit.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) created the catch-up contribution provision, thus allowing older workers to set aside more earnings for retirement.

Here’s what that means in regular language.  If you are age 50 or older you are able to contribute more to your retirement plan.  In 2021 you can contribute an additional $6500 on top of the standard $19,500 contribution limit.  For an IRA, you can contribute an extra $1000 on top of the standard $6000 limit.  Therefore the maximum you can invest in your 401k plan if you are age 50 or older is $26,000 and the maximum for an IRA is $7000.

That’s pretty cool and easy enough to understand.  Here’s a situation that might be helpful if you are a highly compensated employee.

Who’s a Highly Compensated Employee?


A Highly Compensated Employee is anyone who made more than $130,000 in 2020 or anyone who owns more than 5% of the business sponsoring the retirement plan regardless of compensation. 

If you are a highly compensated employee there are rules that could limit the amount you can contribute to your 401k plan.  I have had several clients over the years who contributed to their company’s 401k plan only to receive a check after the end of the year because their company’s plan didn’t pass a discrimination test.  To pass this discrimination test, the average deferral of the highly compensated employees as a group cannot exceed the average deferral of non highly compensated employees by more than 2%. 

If the plan does not pass this test, then they have to make corrections to the plan.  The most common of these is to refund the contributions of the highly compensated employees in order to pass the test. 

This post is not a treatise on 401k plan testing.  I just want to point out something I see quite a bit with my clients. 

Another way to avoid discrimination testing in a 401k plan is to have a Safe Harbor plan.  A Safe Harbor plan is a type of plan with an employer match that allows plans to avoid most annual compliance tests.  A lot of my 401k plans for my owners of private practices such as a dentist office or a law office are Safe Harbor 401k plans.  This enables the owners and the highly compensated employees to make their full 401k and catch up contributions regardless of the amounts contributed by the other employees.

HCE & NO Safe Harbor


What happens if you are a highly compensated employee and your employer’s 401k plan does not have a Safe Harbor provision?  What can you do?

If you are under the age of 50, you will probably be limited to contributing 2% above the average deferral of the group.  When the financial crisis hit back in 2008, there were a lot of companies that stopped the match on their 401k plans.  It’s really weird but when company’s don’t match, a lot of employees won’t contribute to the 401k plan.  When that happens, highly compensated employees often received those refund checks I mentioned earlier. 

If you are age 50 or older and in this situation, you will be able to make the 401k contribution that fits within the discrimination test.  In additions, you can make your catch-up contribution as they are not subject to discrimination testing.  Here’s an example.

Highly Compensated Employee with an income of $200,000.  Because of the plan failing the discrimination test, instead of being able to contribute $19,500 this person might only be able to contribute, $10,000.  However, if this person is age 50 or older, they would be able to contribute $10,000 plus $6500 as a catch-up for a total of $16,500.  Not quite the same as the maximum, but better than nothing.

A Couple More Ideas


What if you are in the under age 50 HCE group.  Are there any other options?  Here are a couple of ideas that might help.

If you are married and your spouse is a participant in a 401k plan you could max out their contribution.  I had a client who was getting caught in the discrimination test and was limited to the amount he could contribute, but his wife was a 401k plan participant and she wasn’t a highly compensated employee.  I told them max out her contribution.  He thought because he was getting refunds it would apply to his wife as well, but that wasn’t correct.

Here’s one more thing to consider.  For 2021, if you are married, filing jointly and you or your spouse are a participant in an employer sponsored plan, in order to make a Roth IRA contribution, your modified adjusted gross income must be under $208,000.  Let’s look at our previous example with the highly compensated employee making $200,000 and getting caught in the discrimination testing.

Although he or she (I don’t care) could not max out their 401k contribution because of the discrimination testing, they were still able to contribute $10,000 into the 401k plan thus reducing their taxable income to approximately $190,000.  At that income level they would be able to make a Roth IRA contribution of $6000 bringing their total retirement plan contributions to $16,000.  Not quite the same as the maximum contribution limit for a non-highly compensated employee but it beats a sharp stick in the eye.

If the person above was age 50 or higher, they could put $16,500 into the 401k plan plus $7000 into a Roth IRA.  This would bring their total contribution to $23,500!

But Wait, There’s More….


Like most of the stuff I write about, it’s impossible to cover all of the possibilities in a rather short blog piece.  If you have questions about this, click on the Get In Touch button at the top of my website.  I’m happy to help you.  If I don’t know the answer, I will get it for you.  As always, thanks for reading!  KB