Companies Must Ensure That 401(k) Participation Is Balanced Among Pay Levels

Q: My employer recently informed me that my contributions to my 401(k) plan will be limited to a maximum of 7% this year because of a ceiling imposed on so-called highly compensated employees. This means that my contributions will not even come close to the $9,500 maximum contribution allowed by the Internal Revenue Service this year. Why am I being denied what I think ought to be a guaranteed right?

--J.H.D.

A: Federal law requires companies offering 401(k) plans to ensure that the tax break offered by these plans is available to all employees regardless of income. However, as you no doubt see, better-paid workers are more likely to take advantage of this savings plan than employees living from paycheck to paycheck.

Because the government doesn’t want 401(k) plans to become tax havens for the rich, it has imposed a series of “discrimination” tests that plans must pass each year to ensure that participation in those plans is balanced among workers in all compensation ranges.

To pass these tests, which set formulas on how much more income highly paid workers can defer from taxation than other workers, many companies find that they must limit contributions from their more highly paid employees. This is what has happened in your case, and there is very little you can do about it. (In extreme cases, companies have been forced to return pretax contributions that employees have already made, potentially creating a tax problem of major proportions for these unsuspecting employees.)

What alternatives do you have? One would be to persuade your employer to mount a campaign to encourage 401(k) membership; many companies offer to match employee contributions to these plans precisely to encourage participation up and down the salary range. Another would be to make a $2,000-a-year after-tax contribution to an individual retirement account. That step won’t give you a tax deduction, but it will at least set up a savings account that will earn tax-deferred interest. A third option would be to check whether your 401(k) plan permits after-tax contributions; many do. Check with your plan administrator.

Securities Sales Subject to Capital Gains Tax Too

Q: I am aware that taxpayers can shelter profits made in real estate investments and on their own residences by rolling the gains over into property of an equal or greater value within the prescribed time limit. Is there a similar rule for stock gains? Can I sell a stock one day and purchase another the following day for equal or greater value and owe no tax on the initial sale?

D.M.

A: No such accommodations exist for securities sales. Gains on stocks and bonds held for investment are subject to capital gains taxes, either as short- or long-term gains.

Gains generated by the sale of securities held for less than one year are considered short-term gains and are taxed at the taxpayer’s ordinary income level. Securities held for one year or longer are considered long-term gains and are also taxed at the taxpayer’s ordinary income level, with one important distinction: Long-term gains are subject to a maximum tax of 28%.

When you actually pay, these taxes will depend on your own circumstances and the operating procedures of your brokerage. If your gains are large and whatever existing withholding tax provisions you have are insufficient to cover your tax obligation, you should file an estimated quarterly tax return to avoid any penalty for under-withholding. Remember, you must prepay your taxes at least to the extent of your tax obligation for the previous year or 90% of the current tax year’s obligation.

Carla Lazzareschi cannot answer inquiries individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business News, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or send e-mail to carla.lazzareschi@latimes.com