COMPENSATIONThe question of compensation seems like it would be very straight forward, but it trips up so many Plan sponsors! There are a lot of nuances to compensation that take careful consideration with every paycheck issued. The Plan document will describe specifically what compensation is to be included when computing benefits earned under the plan. In general, if compensation is included for purposes of the Plan, then elective deferrals should be deducted from that compensation as elected by the Participant and should be included in calculating employer contributions. Some of the options for compensation available for qualified retirement plans include:
- Wages paid and reported on Form W-2
- Wages as described in IRC §415(c) – this is sometimes known as earned income for those who do not receive a Form W-2
- Wages paid during a specific period:
- The Plan year
- A fiscal year ending within the Plan year
- The calendar year ending within the Plan year
- Including or excluding particular types of compensation such as:
- Salary deferrals made to 401(k), 403(b), 457, or cafeteria plan
- Fringe benefit or expense reimbursements
- Compensation paid prior to meeting eligibility requirements for the plan
- Exclusions subject to separate testing for non-discrimination testing (§414(s) test)
- Post-severance compensation
Problem: The compensation on which contributions were calculated was not the same as the compensation as defined in the Plan document.
Fix: Compute the contributions based on the Plan compensation. Deposit additional amounts, plus interest, as necessary. The Plan sponsor should develop policies and procedures to confirm that the correct payroll is used for future calculations and/or amend the Plan document so that future calculations are performed on the compensation that is preferred by the Plan sponsor.
For example: The Avery Toy Co. 401(k) Plan excluded bonuses in its definition of compensation. When the accounting team from Avery Toy Co. provided the 2013 census data to their TPA, they did not carve out the bonuses paid during the year. The TPA computed and allocated the profit sharing contribution to the Avery Toy Co. 401(k) participants based on the total compensation that they had been provided. When it was discovered by the auditors of the Plan that bonus payroll was included in the allocation of the 2013 contribution, the TPA was asked to revise the allocations to exclude the bonuses. When it came time to actually deposit the contribution, the correct allocation report was used.
It is critical to provide your TPA with a listing of all of your employees so that we can insure that you are meeting all of the necessary coverage rules. If you have Union employees, or employees who work outside of the U.S., you may be able to exclude those employees from participation in your Plan, but only if your Plan document specifically excludes them! Other categories of employees – leased employees, part-time, or temporary employees, employees who terminate during the year – may be able to be excluded from your Plan too, but within certain limits. In general, you may be able to exclude up to 30% of your rank-and-file employees without violating coverage rules of your Plan if all of the Highly Compensated Employees are eligible for the Plan.
Employees who are eligible for the elective deferral or employer matching contribution components of your plan are considered “participating” for purposes of the coverage rules even if they elect not to make any elective deferrals out of their paychecks.
Problem: The Company has a policy that excludes a particular group of employees from benefits. As it turns out, those employees represent 50% of all employees, so they can’t all be excluded.
Fix: A minimum number of employees must be included in order to pass the coverage testing rules. Your Plan document will have a section that outlines how employees are brought in to satisfy this rule.
For example: The Bluebird Web Design 401(k) plan allows for eligibility after 6-months of service, but excludes temporary employees from eligibility. In 2013 Bluebird had 1 owner (HCE) and 10 full time staff who were all hired in 2012 or earlier and 5 temporary employees who 3 of whom had worked for 8 months. Two of the full time staff terminated during 2013. The company planned to make a $10,000 profit sharing contribution to the Plan for 2013. How many employees would be eligible to share in the profit sharing?
10 full time staff are counted for coverage testing
3 temporary employees must be included in the coverage test (they had met eligibility)
13 total included in the testing
10 must be covered to meet the 70% rule (13*70% = 9.1)
The full time staff will be eligible to share in the profit sharing contribution, along with the owner. The temporary employees may be excluded.
You might also like: