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Hey everyone, welcome to Episode 105 of Money Girl.
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This is Finance Friday, where I answer your burning money questions.
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I'm Laura Adams, an award-winning author, spokesperson, money-speaker, and founder of
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That's my sub-stack newsletter.
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You can sign up and learn more at LauraDatoms.com.
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Today, I have a great question that I don't think I've ever received before.
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It comes from Jay P, who says, over the last seven to eight years with two different employers,
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they've returned some of my 401k contributions due to failing the discrimination test.
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It seems unfair to penalize me for my co-workers' lack of contributions.
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Thank you so much for your question, Jay.
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I can definitely hear your frustration about not being able to make more contributions
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to your retirement plan.
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In this podcast, I'll explain what the retirement non-discrimination test is and what to do
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if your contributions get returned.
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So first, let's talk about what exactly I'm talking about with the non-discrimination
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Employers that offer workplace retirement plans get benefits from doing that, like getting
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a tax deduction for paying matching contributions.
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In addition, employees who participate get valuable benefits, like deferred taxes on contributions
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and investment growth.
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In exchange, the Internal Revenue Service, or IRS, requires that certain retirement plans
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not disproportionately favor highly paid employees or company owners, they require annual
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non-discrimination testing to enforce an acceptable balance of participation that
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doesn't unfairly benefit top earners or the rest of the workforce.
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Employers have to use various non-discrimination tests that compare the average savings or
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ownership status of highly compensated employees or HCEs to the average savings of everybody
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The calculations get a bit complicated and they do vary depending on the plan, so I'm
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going to spare you all the details on the calculations.
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However, I will say for 2026, you're considered a highly compensated employee if you earned
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over 160,000 or own more than 5% of the company in 2025.
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And that amount is likely to go up in future years.
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So if the gap between retirement contributions and matching contributions for highly compensated
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employees and the rank and file workers is too wide, it means that typical workers
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aren't participating enough and the plan will fail the non-discrimination test.
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To remain compliant, a company with a failed retirement plan must refund excess contributions
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to the high earners to correct the discriminatory participation imbalance.
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That's why Jay has had some of his retirement contributions bounce back to his checking
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account as regular income from a couple of his employers.
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I know Jay's frustration about being a good saver might seem like a champagne problem
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He's doing everything right by making 401k contributions and prioritizing his future.
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Yet a portion got returned because his co-workers aren't saving enough.
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Now you can't force colleagues to contribute more to a workplace retirement plan.
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There are solutions for changing the plan or putting returned contributions to work in
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a different account so they keep growing.
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So first I want to review a type of plan that allows an employer to avoid these annual
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non-discrimination tests that I'm talking about.
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And not having these tests can alleviate a significant administrative burden to encourage
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more employers to offer retirement benefits.
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The IRS created a workplace plan with no testing requirements and it's called a Safe Harbor
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Now the catch with a Safe Harbor 401k is that an employer agrees to make specific mandatory
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contributions to its employees' accounts.
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For instance, it could match up to 4% of employees' pay with immediate investing.
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In return, the IRS waives the employer's non-discrimination test entirely.
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So one solution for Jay would be convincing his human resources manager or benefits administrator
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to change the company's retirement plan to a Safe Harbor 401k, you know, maybe it would
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begin in the following year.
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That would be the ultimate fix.
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In that case, it could no longer tie Jay's contributions to his co-workers' participation.
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He could max out the account by contributing 24,504,206 or even more if he's over age
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50, without any fear that a portion could get returned at the conclusion of the tax
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Jay could explain to his employer how a Safe Harbor 401k would be a win-win.
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His company would offer a more competitive retirement benefit and get to skip the onerous
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annual non-discrimination testing.
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However, I realize that his employer may not feel so generous about offering a Safe Harbor
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401k that requires a matching benefit.
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That could be especially true if Jay's employer is a smaller firm that might struggle to offer
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a richer benefits package.
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Another solution could be for Jay to encourage his employer to automatically enroll new employees
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into the retirement plan while allowing them to opt out, you know, if that's not already
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the case, auto enrolling workers has shown to increase overall participation rates in
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Or Jay could ask for more education in the workplace about retirement planning and using
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a 401k, which could improve enrollment.
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That would help workers build stronger financial futures and allow highly paid workers to
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However, if Jay works for a small company, there may not be a large number of workers or
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new hires who could participate enough to make the discrimination testing work in his favor.
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So let's say you're like Jay and have gotten returned retirement contributions.
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I want you to remember that they may be taxable.
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For instance, any traditional pre-tax contributions will get added to your taxable income for
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So before spending them, consider holding back at least 20-25% for future taxes.
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However, if you made any after-tax Roth contributions that get returned to you, they will not affect
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your tax liability because they were previously included in your taxable income.
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While you might be disappointed to have your retirement contributions denied or returned,
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you can still invest them.
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An excellent option is to use them to max out a health savings account or HSA if you
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have an HSA-qualified health plan.
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Since HSA contributions are made on a pre-tax basis, they will help you reduce your tax liability.
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For 2026, you can contribute up to $4,400 to an HSA when you have an individual health
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plan or $8,750 with a family plan.
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In addition, you can contribute an additional $1,000 if you're over $55.
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As I mentioned, HSA contributions are tax deductible just like a traditional 401k.
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However, you do have to spend them on eligible health care expenses or just keep the account
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invested for retirement.
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The amazing benefit of an HSA is that you can spend the funds tax-free on qualified
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Now another excellent way to invest returned workplace retirement contributions is to
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put them in a Roth IRA if you qualify.
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For 2026, you can contribute up to $7,500 or $8,600 if you're over $50 to an IRA.
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If J is a single taxpayer, the 2026 income limit to max out a Roth IRA is $153,000.
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If you're married couples filing jointly, their household income must be under $242,000.
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However, you can only contribute after tax funds to a Roth IRA, so they're not going
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to help reduce your tax liability.
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Let's say J earns too much for a Roth IRA.
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In that case, another great way to invest any returned retirement contributions is putting
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them in a taxable brokerage account.
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Now, it doesn't give you any tax breaks, but it is extremely flexible and can be tapped
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penalty-free before or during retirement for any purpose.
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J, I want to thank you again for your great question and I hope this gives you some
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options for discussing the benefits of a safe harbor 401k with your employer or alternative
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ways to invest when you're a highly compensated employee and your 401k fails a nondiscrimination
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I'll talk to you soon.
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Until then, here's to living a richer life.
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Money Girl is a quick and dirty tips podcast and we've got a great team.
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I want to thank Steve Erickie Bird, who audio engineers the show.
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Holly Hutchins is our director of podcast.
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Morgan Christensen is our advertising operations specialist.
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Rebecca Sebastian is our marketing and publicity manager.
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Nathaniel Hoops is our marketing contractor and Maram Elnageeb is our podcast associate.