Providing compensation to the TPA for your retirement plan should be easy, right? It’s surprising how many issues come up with compensation, and how providing the incorrect compensation to the TPA may end up causing headaches. This is a basic primer for the definition of compensation for retirement plans – whether you’re setting up a new plan, or working with your existing plan.
BASIC DEFINITION
Your plan document will provide a compensation definition for purposes of allocating contributions for the plan. There are three basic options from which to choose for your starting point:
- W-2 wages. These are wages reported on Form W-2.
- Code Section 3401(a) wages. This is compensation that is subject to income tax withholding purposes.
- 415 safe harbor compensation. Wages, salaries and fees for professional services rendered in the course of employment. Includes net income for sole proprietors and partners.
OPTIONS TO INCLUDE IN COMPENSATION
Elective provisions in the plan document also allow you to include various compensation that may or may not be included in the basic election. For example, salary deferrals for 401(k), 403(b), 457(b), or cafeteria plans are not reported on Form W-2, but the employer can elect to include these deferrals in the definition of compensation. They often reason that they do not want to reduce eligible compensation for someone who is participating in the plan.
Compensation paid after severance from employment is often included too. These are checks paid to cash out unused vacation, or final payroll that are issued after the official termination date, but paid within 2 ½ months of that date. Including this compensation avoids having to carve out that last paycheck when providing compensation to the TPA.
OPTIONS TO EXCLUDE FROM COMPENSATION
For the most part, all remuneration is considered compensation. The plan sponsor can elect to exclude a variety of compensation. Exclusions must be non-discriminatory – exclusions cannot impact only non-owners or non-highly compensated employees. Examples of compensation that can be excluded are:
- Compensation paid prior to entering the plan
- Fringe benefits or expense allowances
- Overtime
- Bonuses
- Commissions
COMPENSATION IMPACTS MANY ASPECTS OF THE PLAN
The Annual Data Request that we send to our clients includes a column to list excluded compensation for each person with a reminder about what that compensation is. We also provide a tool to compare the annual payroll reports to the amount of compensation that is reported to us. Having the correct compensation for the plan is critical, because compensation is used for:
- Contribution allocations. Any employer contributions made to the plan are most often determined by compensation.
- Compliance testing. 401(k) tests, and non-discrimination tests all need the correct compensation to be performed properly
- Status. The determination of Highly Compensated Employee and Key Employee are always based on total compensation prior to any exclusions.
SUMMARY
It is critically important to understand your plan’s definition of compensation, and to provide the correct information to your TPA every year. In the event you provided incorrect compensation in a prior year, there are correction programs available through the IRS that allow you to fix the problem.
If you think that modifying your plan’s definition of compensation might improve your goals for the plan, or if you are curious about the options available, just click here to request a consultation with one of our consultants. As your TPA, Benefit Resources is always looking out for your best interest!
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