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Limit on 401(k) Savings Depends as Much on Company Participation as on IRS Rules


Q: For years I have heard that I should save more for my retirement because the Social Security system may not provide all that I will need. However, for each of the last two years, my company has informed me that I have contributed too much to our 401(k) plan, even though I have not reached the IRS limit. In both instances, a portion of my contributions was refunded. Why does this happen? And more important, what can I do to save more money on a tax-deferred basis?


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, 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 the plans must pass each year to ensure that participation is balanced among workers in all compensation ranges, not just the so-called "highly compensated" workers.

In general, the government classifies those earning in the top 20% of a company's wage scale as "highly compensated." If a company's plan flunks the discrimination test because too many workers in this top range have participated relative to a company's entire work force, the amount that highly compensated workers may defer in a 401(k) plan is reduced to an amount specifically determined as appropriate for the individual company for that specific year.

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.

(By the way, beginning this year, companies can avoid the discrimination test entirely by offering a "simple" 401(k) plan. In these, employers are deemed to have satisfied the discrimination test by limiting elective deferrals to $6,000 annually by all employees--the government's limit was $9,500 for 1996--and by either matching the first 3% of compensation deferred to the plan or contributing 2% of all compensation for all eligible employees earning at least $5,000 annually.)

What alternatives, beyond the simple 401(k) plan, do you have right now? One would be to persuade your employer to mount a campaign to encourage 401(k) membership.

One reason many companies offer to match a portion of their employees' contributions to 401(k) plans is to lure lower-paid workers into joining. And why shouldn't they? Employees who don't are passing up free money if their employers offer to match part or all of their contributions. It's that simple. If enough new members from the lower-paid ranks are drawn in, your contribution level could be increased.

Another alternative would be to make a $2,000-a-year after-tax contribution to an individual retirement account. That won't give you a tax deduction, but it will 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.

One more possibility--perhaps a long shot--would be to persuade your employer to establish a "non-qualified" plan for highly compensated employees whose 401(k) contributions have been restricted. You would be wise to consult your employee benefits administrator.


Q: We paid our landscaper $2,500 for some work. He said the check never arrived at his business, so we stopped payment on it and issued another. Now we find, some 15 months later, that he cashed the first check that we thought we had stopped. I don't think the bank should have honored that dead check. Who's right?


A: There is no such think as a "dead," "stale" or "dated" check. Once a check is written, banks consider it a contract to pay the amount specified.

You can, however, issue a stop-payment order. These orders are good for just six months and must be renewed--at a cost of at least $10 per incidence--every six months. In your case, the stop-payment order had expired. Your landscaper probably knew that and assumed you hadn't renewed the order.

What could or should you have done to protect yourself? Banks advise that when you are dealing with a hostile or perhaps dishonest payee, you should cancel the account on which the check was written rather than continually pay for stop-payment orders.

Why should a bank honor a check that is months or even years old? A spokesman for Bank of America, the state's largest bank, reminds us that checks are generally read and paid by machines.

These machines don't read dates, just the magnetic codes, and are programmed only to check your account balance to ensure that there is enough money to cover the draft.


Q: In a recent column, you said the taxable basis of stock left to an heir is generally set as of the donor's date of death. Would this also apply to annuities?


A: No. Although the government allows a step-up in basis for such assets as real estate, stocks and collectibles, it does not afford the same treatment to what are called ordinary income assets.

These include IRAs, pensions, installment sale notes, annuities, U.S. Treasury securities and Savings Bonds.

The reason for treating these assets differently from real estate, stocks and the like, say our experts, is that the deceased taxpayer had elected to defer taxation on these ordinary income assets by putting money into these investments.

Just because the taxpayer wants to defer taxes on investments doesn't mean Uncle Sam is willing to forgive the tax bill.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail

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