401(K) Deferral Example
Course: Retirement Planning
Lesson 3: Employee Protections and Employer Responsibilities in Qualified Plans
Student Question:
I failed to understand how $11,600 would be the correct answer to the question below. Can you go through the actual calculation?
Belinda Bigbux (age 40) earns $1,000,000 annually as a test pilot. She wishes to defer 10% of her compensation on a pre-tax basis into her company’s 401(k) Plan in 2021 (the current year). The NHCEs who participate in the 401(k) Plan deferred 2% last year.
How much can Belinda defer in the current year?
$100,000
$29,000
$19,500
$11,600
Thanks for your help.
Emerito
Instructor Response:
Hi Emerito,
Good to hear from you. Happy to help here. So, because the NCHEs in this example contributed 2% last year, the ADP Test defines the contribution for this year for HCEs to be 4%. We arrive at 4% because it is 2% more than the NCHEs contributed last year.
What do we apply that 4% against? Well, the compensation limit for calculating contributions is $290,000 in 2021, so even though she earns $1,000,000, we can only use $290,000. Thus, 4% of $290,000 is $11,600.
Does that help clarify? Let me know any further questions!
Dan
