Let me start off by saying - I know it is my obligation as a citizen to pay my fair share of taxes and I make sure my employer withholding every year is right on target to meet my tax obligations. I may not like the amount of money chopped off my paycheck, but neither does any other citizen. It is one of those things we know we must, but wish we didn't have to.
My problem revolves around the "wonderful" legislation that dictates the Highly Compensated Employees (HCE) rules. These rules are applied in a blanket manner across this country, whether you live in Wyoming, Texas, New York or California - you become an HCE if you either own 5% of the business or earn more than $115,000.
Once you become an HCE in the eyes of the IRS, you are no longer eligible for several education related tax deductions - and that is right, because those deductions were designed to protect the lower income population.
However, there is another side to the HCE rules. That side relates to the 401K and IRA tax deductible status. Ordinarily, employees are allowed to contribute money from their earnings towards these retirement plans. For 401K, the contributions are pre-tax and for IRA the contributions can be deducted from your taxable income when filing your return. Both plans allow investments to grow tax-deferred for the life of the plan.
When applying the HCE rules, which were advertised by our Washington legislators to the public as "making sure lower income individuals benefit from retirement plans as well as the HCEs", they were actually trying to apply the proverbial 'defibrillator' to the US Treasury investment (as most safe components of any retirement plan contain a healthy dose of Government Bonds and Treasury Bills).
Their crazy way of thinking was explained - each company will have to undertake a 'stress test' to make sure that their lower earners benefit in no lesser proportion than their HCEs. Meaning if the lower earners don't contribute to the 401K plan or don't contribute enough, the HCEs become ineligible for the tax-deductible status of their 401K contributions and will have a refund of those contributions issued (which will then be considered taxable income).
The rationale was - the company HR and the HCEs should encourage the lower income employees to participate fully in the 401K program. Sounds like a collective social pressure applied to a work environment in order to pump up the Government's Treasury bottom line. Don't worry, comrade, the government has your best intentions in mind.
But this idea backfired - you cannot convince lower earners, some of whom live paycheck-to-paycheck, to contribute to 401K the money that they simply do not have to spare. As a result, the lower earners will not contribute because they cannot afford to and the HCEs will not contribute because they have been flagged as ineligible. In conclusion, unless this legislative mess is corrected, the 401K and IRA plans will suffer a contraction - one which will negatively impact the US Treasury investments (the exact opposite of what this legislation intended to do).
P.S. Consider the inconsiderate nature of this legislation - the HCE 'stress test' will surely pass an Investment Bank or a Law Firm, where every HCE will remain eligible for 401K's tax deductible status. Then consider a consulting company, where a lot of workers are per diem, don't earn enough to be considered an HCE and typically do not contribute to the company's retirement plans. The people who just barely meet the HCE criteria (through pulling in a lot of extra overtime) will now be unfairly punished simply because of the per capita income composition of their company. Also, geographically a non-HCE employee earning under $115,000 will probably be able to contribute to a greater degree in remote areas of Texas and Florida (where there is no state income tax to chop off your paycheck and the cost of living is relatively low), as opposed to New York and California (where state taxes are quite high and so is the cost of living).
