Got The Big Raise? Great. There Goes Your Retirement Rules on 401(k) saving for higher-paid workers mean they could end up with less.
(FORTUNE Magazine) – If you're about to join the eight million or so working Americans who make more than $90,000 a year, congratulations! But beware: Your success today could jeopardize your financial well-being in retirement.
Here's why: The IRS considers anyone who's making more than $90,000 a year (including salary, bonus, commissions, and overtime) to be "highly compensated" for the purposes of a 401(k) plan. That's a crucial distinction. Under the agency's "antidiscrimination" rules, the percentage of pay that a highly compensated employee may contribute to his 401(k) is capped at about two percentage points more than the average amount those in the lower-paid group contribute. That shakes out to an average of about 7% of pay for highly paid folks, according to David Wray, president of the Profit Sharing/401(k) Council of America. It also means your allowable contribution could drop dramatically.
Consider this scenario: A company's 401(k) plan allows lower-paid employees under 50 to contribute a maximum of 20% or $13,000, whichever is less. So a 40-year-old employee making $85,000 plans to sock away the whole $13,000. If, however, his pay gets bumped to $90,000 his contribution is now limited to 7%, or $6,300. Extrapolate that annual difference over 25 years (at a 6% average return), and he'd have about $368,000 less at age 65.
Companies can take steps to eliminate the contribution cap, usually by beefing up match-ing programs. If you're expecting to cross the $90,000 threshold, call your benefits depart-ment to ask what your limit will be. Otherwise, be prepared to save more outside your 401(k) plan. And be sure to max out on your 401(k) while you still can. "When you're about to get that big raise, plan ahead--you'd better save every penny you can this year," advises Wray.