I have a client who has an employee eligible to start deferring into the 401k as of 7/1/03, however the employee has already made $200,000 in comp by 7/1. The payroll company & 401k provider have said he cannot defer into the plan once he reaches $200,000.

My question is, if he has just become eligible and has not hit the $12,000 limit (or any other plan imposed limits) why can't he defer? What am I missing?

Thanks in advance!

This is a common misconception, and it is disturbing to see it being perpetuated by the groups that should know better - payroll providers and 401(k) plan providers. The problem is that their systems are set up on the assumption that the deferrals must come out of the first $200,000 earned because that is administratively easier for them. But this is not how the limit should be applied. The $200,000 limit is the most that can be used to compute a contribution. Therefore, the $400,000/ employee who contributes $12,000 (whether from his first $200,000 or the next $200,000 earned during the year) has, for testing and matching contribution purposes, contributed 6% of his "compensation" (applying the $200,000 limit) and not 3%.

Unless the Plan Document limits deferrals to a specified percentage of compensation he should be able to defer.

There have been a few recent threads on this.

http://www.benefitslink.com/boards/index.p...=20&t=20967&hl=

But what does the plan say?