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401k safe harbor12/29/2023 Learn how to avoid these mistakes in this free guide. Processing payroll doesn’t have to be complicated or expensive-but if you’re doing it the wrong way, it can be both. This is a source of frustration to highly compensated individuals, because they can’t max out their contributions, thus lessening their ability to reach their investment goals with their 401(k) plans. Everything above that is returned to them as compensation-and it is taxed. Under the ADP and ACP testing rules, the highly-compensated employee can contribute only 4%, which is based on the average of the non-HCE group rate, plus an additional 2%. ![]() The 5 employees are considered non-participating because they are eligible to participate and don’t their non-participation brings down the average. Thus, the average of those 10 eligible employees is 2% of the entire group. Of those 5 employees, each contributes 4%. Of the remaining 10, only 5 contribute to a traditional 401(k) plan. Of those 11 people, only one is considered highly compensated. Imagine your company has 11 people who are eligible to contribute to a 401(k) plan. Looking for a clear, thorough guide to the entire payroll process for small businesses? Download The Small Business Guide To Payroll In many cases, they get a refund for excess contributions, because as a general rule, highly compensated employees can’t contribute more than 2% of the average of all other employees who are eligible to participate. Oftentimes, owners try to stash away the maximum amount allowable per year, unaware they may be over-contributing to the plan. Key employees are defined as employees who own more than 5% of the business, their spouses, and lineal relatives, as well as certain shareholders and company officers.
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