Annual Refund Reflects Legal Limits on 401(k)
Q: Every year I contribute the maximum allowable to my company’s 401(k) plan. Without fail, during the first quarter of the following year I get a fat check back from the plan with a nice letter stating that the plan has been deemed to be “discriminatory” and my maximum contribution must be scaled back. What’s going on here? I’m annoyed and need help. --C.P.M.
A: It’s not surprising that you should be annoyed. After all, you have tried to take advantage of one of the few remaining middle-class tax loopholes and have come up short. And it probably won’t make you feel any better to know that your company is acting properly.
Federal law requires companies offering 401(k) plans to ensure that the tax break offered by these plans--remember, the money you sock away in these accounts is tax deferred--is available to all employees regardless of their income. You can easily see that better-paid workers are more likely to take full advantage of a tax-deferred savings plan than employees who live from paycheck to paycheck, barely covering their expenses. But the government doesn’t want 401(k) plans to become savings accounts strictly for the rich, and it has imposed a series of “discrimination” tests that the plans must pass each year to ensure that lower-paid employees are participating in the plans along with their better-paid colleagues. Plans failing these tests must refund contributions made by the more highly paid employees.
How do the tests work? They’re complicated, but in essence they divide a company’s employees in two groups: “highly compensated” employees and everyone else. Although the government allows the highly compensated group to contribute more to the 401(k) plan--as much as twice the rate of the other group--there are certain limits that must be met to satisfy the government that the plan is not being run as a tax loophole for the rich. One of the reasons employers match employee contributions to 401(k) plans is to help lure lower-paid employees into setting up the accounts.
However, in many cases, employers discover during their end-of-the-year audits that the contributions from highly compensated employees were too great in comparison to those from the other group. In these cases, the plan must refund a portion of the contributions to the highly compensated employees. These “year-end corrections,” as they are known, can then become quite complicated, even political. Should all highly compensated employees get the same amount back? Or should refunds be pro-rated based on the amount of contribution? As you can see, it can get messy. You should read the fine print of your 401(k) plan’s administrative rules to determine how your refund was determined.
Does a Boat Qualify as a Vacation Home?
Q: I have a home and a 40-foot boat on which I pay property taxes. Why can’t I deduct the property taxes for my boat on my income tax filing? I spend weekends on the boat. Wouldn’t this qualify it as a vacation home? --H.H.H.
A: Regardless of whether you spend every weekend on your boat or no weekends there, any property taxes you pay to berth the vessel are a legitimate income tax deduction as real property taxes.
The other, more pertinent, question would seem to be whether you are able to deduct any interest you are paying on a boat purchase loan as second home mortgage interest. The answer to that is “yes,” so long as the boat can legitimately be used as a home. How do you know if your boat qualifies? The most practical test, say our experts, is whether the boat has the necessary toilet facilities to allow someone to live there.
IRA Can’t Be Used for Loan Collateral
Q: Within the next few months I will receive a $32,000 disbursement from a profit-sharing plan I had with a previous employer. I plan to roll this money into an individual retirement account. However, my husband and I want to start a small business and are wondering if there is any way we can use this money as collateral for a business loan. Maybe there is some other way we could tap into it without having to pay taxes? --N.J.H.
A: Our experts know of no legal way for you to use your IRA to help start your new business without subjecting yourself to both taxation and a 10% penalty for premature distribution. Even using your account merely as collateral for a loan qualifies as taking a taxable distribution.
For Jobless Benefits, Age Is No Barrier
Q: I am 71 years old and receive a small pension in addition to my Social Security. I am currently employed but fear that I will soon be laid off. Do I qualify for unemployment insurance if I am unable to find another job? --M.B.
A: Age is no barrier to qualifying for unemployment insurance in this state. The sole issues are whether you lost your job through no fault of your own and whether you are available for new employment. If both answers are “yes,” then you are eligible to collect unemployment compensation. However, depending on the type of pension you are receiving, you may not get all the insurance benefits you are otherwise entitled to. If your pension is 100% paid by your former employer, your unemployment insurance benefits will be reduced by the amount of your pension. If, however, you contributed to your pension account in any way during your earlier employment, your jobless benefits will not be reduced.
