Are you a highly compensated individual looking to maximize your 401(k) contributions for the 2023 tax year? Excellent! It's a smart move to leverage every possible avenue to boost your retirement savings, especially with the favorable limits and rules in place for those with higher incomes. This guide will walk you through everything you need to know, from understanding what classifies you as a Highly Compensated Employee (HCE) to the specific contribution limits and advanced strategies. Let's dive in and make sure you're on track for a financially secure future!
Maximizing Your 401(k) as a Highly Compensated Employee in 2023
As a highly compensated individual, your 401(k) contributions come with a few extra considerations and nuances compared to non-HCEs, primarily due to IRS nondiscrimination rules. These rules are in place to ensure that retirement plans don't disproportionately benefit high-earners. But fear not, there are still ample opportunities to contribute substantially to your future.
Step 1: Confirm Your Highly Compensated Employee (HCE) Status for 2023
Before we delve into the numbers, it's crucial to understand if the IRS considers you a Highly Compensated Employee (HCE) for the 2023 plan year. This status often impacts how much you can actually defer into your 401(k) due to nondiscrimination testing.
What Defines an HCE for 2023?
For the 2023 plan year, you are generally considered an HCE if you meet either of the following criteria:
Ownership Test: You owned more than 5% of the company sponsoring the plan at any time during the current plan year (2023) or the preceding plan year (2022), regardless of your compensation. This includes direct and indirect ownership (e.g., through family attribution rules).
Compensation Test: You received more than $150,000 in compensation from the employer in the preceding plan year (2022). Some plans may elect to limit HCEs based on compensation to the top 20% of highly paid employees.
It's important to note that even if you meet the compensation test, your plan might still allow you to contribute more than others if the plan passes its nondiscrimination tests.
Step 2: Understand the Base 401(k) Contribution Limits for 2023
Regardless of HCE status, there are universal limits that apply to all participants in a 401(k) plan.
Employee Elective Deferral Limit
For 2023, the maximum amount you could contribute from your salary as an employee elective deferral to your 401(k) (including Roth 401(k) contributions) was $22,500. This limit applies across all your 401(k) plans if you participate in more than one (e.g., if you changed jobs during the year).
Catch-Up Contributions (Age 50 and Over)
If you were age 50 or older by the end of 2023, you were eligible to make an additional catch-up contribution of $7,500. This increased your total personal elective deferral limit to $30,000 ($22,500 + $7,500). This catch-up contribution is generally not subject to the same nondiscrimination testing as regular elective deferrals.
Step 3: Factor in the Overall Defined Contribution Limit for 2023
This is where the concept of "highly compensated" really comes into play, as the IRS sets an overall limit on total contributions to a participant's defined contribution plan account each year.
Total Annual Additions Limit
For 2023, the total amount that could be contributed to your 401(k) account from all sources (your elective deferrals, employer matching contributions, employer nonelective contributions, and allocations of forfeitures) was the lesser of:
100% of your compensation, or
$66,000 ($73,500 including catch-up contributions if you were 50 or older).
This means that even if you are an HCE, your combined employee and employer contributions cannot exceed this overall limit.
Compensation Limit for Contribution Calculation
The IRS also caps the amount of compensation that can be taken into account when determining contributions (both employer and employee). For 2023, this compensation limit was $330,000. So, even if you earned more, your 401(k) contributions would be calculated based on a maximum of $330,000 in eligible compensation.
Step 4: Navigate Nondiscrimination Testing (ADP/ACP Tests)
As an HCE, your actual contribution amount might be limited not just by the direct IRS limits, but also by your plan's ability to pass nondiscrimination tests. These tests (specifically the Actual Deferral Percentage, or ADP, test and the Actual Contribution Percentage, or ACP, test) ensure that 401(k) plans don't unfairly favor HCEs over Non-Highly Compensated Employees (NHCEs).
How the Tests Work
ADP Test: Compares the average deferral percentage of HCEs to that of NHCEs.
ACP Test: Compares the average employer matching contributions and after-tax employee contributions of HCEs to that of NHCEs.
Generally, the average contribution rate for HCEs cannot exceed the average contribution rate for NHCEs by more than 1.25 times, or by more than 2 percentage points (whichever is less).
Potential Impact on HCEs
If your company's 401(k) plan fails these tests, HCEs may be required to receive a refund of some of their excess contributions (known as "excess contributions" or "excess aggregate contributions"). This is why sometimes, even if you want to contribute the maximum, your plan administrator might inform you of a lower limit to ensure the plan passes testing.
Some plans use a "safe harbor" design to automatically pass these tests, allowing HCEs to contribute up to the full IRS limits without worrying about refunds.
Step 5: Explore Advanced Strategies for HCEs (if your plan allows)
If you've maxed out your pre-tax or Roth 401(k) contributions and your employer's contributions, and your plan allows for it, there are still ways for HCEs to save more for retirement.
After-Tax 401(k) Contributions and the "Mega Backdoor Roth"
This is a powerful strategy for high earners, but it depends entirely on your 401(k) plan's provisions.
Make After-Tax Contributions: Some 401(k) plans allow you to make contributions with after-tax dollars beyond the regular elective deferral limits, but still within the overall defined contribution limit ($66,000 for 2023, or $73,500 with catch-up). These contributions are not tax-deductible, and their earnings are taxable upon withdrawal (like traditional 401(k) earnings).
Convert to Roth: The magic happens when you convert these after-tax contributions to a Roth 401(k) (if your plan offers in-plan Roth conversions) or roll them over to a Roth IRA. When these after-tax funds are converted to Roth, the principal is tax-free, and any future earnings within the Roth account grow and can be withdrawn tax-free in retirement (assuming qualified withdrawals). This is often referred to as a "Mega Backdoor Roth."
This strategy allows you to get more money into a Roth account than the direct Roth IRA income limits would otherwise allow.
Solo 401(k) for Self-Employed HCEs
If you're a highly compensated individual who also has self-employment income (even a side gig), a Solo 401(k) can be an excellent way to supercharge your retirement savings. With a Solo 401(k), you act as both the employee and the employer.
Employee Contribution: You can contribute up to the employee elective deferral limit ($22,500 for 2023, or $30,000 if 50 or older) from your self-employment income.
Employer Contribution: You can also make a profit-sharing contribution as the employer, typically up to 25% of your net adjusted self-employment income.
The combined employee and employer contributions to a Solo 401(k) are subject to the same overall defined contribution limit ($66,000 for 2023, or $73,500 if 50 or older). This means you could potentially contribute the full overall limit yourself through a Solo 401(k), far exceeding what you might be able to contribute to a traditional employer-sponsored plan as an HCE.
Step 6: Review Your Plan Document and Consult Professionals
The specific rules and options available to you will ultimately depend on your employer's 401(k) plan document.
Always check with your HR department or plan administrator to understand your plan's specific rules, especially regarding HCE limits, nondiscrimination testing, and the availability of after-tax contributions or in-plan Roth conversions.
Consider consulting a financial advisor or tax professional. They can help you navigate the complexities of HCE rules, optimize your contribution strategy, and ensure you're complying with all IRS regulations.
By following these steps and understanding the intricacies of 401(k) contributions for highly compensated employees, you can significantly boost your retirement nest egg and ensure a comfortable financial future.
10 Related FAQ Questions
How to determine if I am a Highly Compensated Employee (HCE) for 2023?
You are generally an HCE for 2023 if you owned more than 5% of the company at any time in 2022 or 2023, OR if you earned more than $150,000 in compensation in 2022.
How to contribute the maximum employee deferral to my 401(k) in 2023?
For 2023, the maximum employee elective deferral was $22,500. You contribute this by setting your payroll deferral amount with your employer's HR or benefits department.
How to make 401(k) catch-up contributions if I'm over 50 in 2023?
If you were age 50 or older by the end of 2023, you could contribute an additional $7,500 as a catch-up contribution, increasing your personal deferral limit to $30,000. Inform your plan administrator that you wish to make catch-up contributions.
How to understand the overall 401(k) contribution limit for 2023, including employer contributions?
The overall limit for total contributions to your 401(k) in 2023 (employee + employer) was $66,000, or $73,500 if you were 50 or older and made catch-up contributions. This limit is the lesser of the dollar amount or 100% of your compensation.
How to use after-tax 401(k) contributions for a "Mega Backdoor Roth" in 2023?
First, ensure your 401(k) plan allows after-tax contributions. Then, contribute post-tax dollars up to the overall $66,000/$73,500 limit. Finally, convert these after-tax funds to a Roth 401(k) (in-plan) or roll them over to a Roth IRA.
How to find out if my 401(k) plan allows after-tax contributions or Roth conversions?
You need to check your 401(k) plan's Summary Plan Description (SPD) or contact your HR department or plan administrator directly. These features are not universally available.
How to avoid having my 401(k) contributions as an HCE limited by nondiscrimination testing?
If your plan fails nondiscrimination testing (ADP/ACP tests), your contributions as an HCE might be limited. Some plans are "safe harbor" plans, which are designed to automatically pass these tests, allowing HCEs to contribute the maximum.
How to maximize my retirement savings if I am self-employed and a Highly Compensated Employee?
Consider setting up a Solo 401(k). As both employee and employer, you can contribute up to the employee deferral limit ($22,500 in 2023, or $30,000 with catch-up) plus an employer profit-sharing contribution (up to 25% of net earned income), up to the overall limit of $66,000 ($73,500 with catch-up).
How to know the compensation limit used for 401(k) contributions in 2023?
For 2023, the maximum compensation that could be taken into account for 401(k) contribution calculations was $330,000.
How to get professional advice on my HCE 401(k) contributions?
Consult with a qualified financial advisor who specializes in retirement planning and/or a tax professional. They can provide personalized guidance based on your specific financial situation and your employer's plan details.
