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Match Allocations and Annual Compensation Limits


King of Queens
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I'm looking to see how others are handling the following:

The plan sponsor has a 401(k) Plan that provides a match formula equal to of 100% of the first 6% contributed.  The contributions are deposited semi-monthly.  Assuming the HCE has not received the maximum match allocation of $17,100 (6% of $285,000) at the time the compensation reaches the $285,000 limit, would the HCE be entitled to additional match allocations on deferral contributions for compensation earned over the $285,000 limit.  The plan has no true-up provision and the document defines the match determination period as "each payroll period" and not "the Plan Year".  Some people say the match allocation must stop when the compensation reaches to $285,000 limit.  Others say the match allocation can continue (up to the plan formula maximum) on compensation in excess of the $285,000 as long as there are corresponding deferral contributions.  

Should the match allocations stop or should they continue?

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Welcome to the message boards.

The IRS has said (informally, not in regulations) that the participant can keep making elective deferrals and the match can continue to be allocated on compensation over the 401(a)(17) compensation limit assuming that when one looks at the plan year as a whole that 402(g) & plan match limits considering the compensation limit have not been exceeded and HCEs can't contribute a greater % than NHCEs do.  Ideally, the plan document would contain language clarifying this but that's not required.

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The IRS has a page on their website about this.

https://www.irs.gov/retirement-plans/401k-plans-deferrals-and-matching-when-compensation-exceeds-the-annual-limit

But, note that match can not be allocated based on compensation in excess of the 401(a)(17) limit.  If you don't want the HCE's match to be smaller because of the timing of their deferrals, amend to provide for a true-up or to allocate the match using plan year compensation.

 

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I read that link to state that except in the uncommon case where a plan document states that contributions cease after the first $280,000 (now $285,000) of compensation, then both deferrals and match may continue.  Overall match is limited to the dollar amount determined by applying the plan's matching formula to the $285,000 compensation limit.

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You are mixing sections from the site.

Quote

What does your plan say?

Although not common, a plan can specifically require that salary deferrals cease once a participant’s compensation reaches the annual limit.

If your plan specifies that salary deferrals be based on a participant’s first $280,000 of compensation, then you must stop allowing Mary to make salary deferrals when her year-to-date compensation reaches $280,000, even though she hasn’t reached the annual $19,000 limit on salary deferrals, and must base the employer match on her actual deferrals.

 

This only refers to stopping deferrals when the compensation limit is hit, not the match.  The section before it is very clear that you have to follow the plan's match formula.  Our VS base document allows for a discretionary match equal to the true-up contribution that would have been required if the match was based on annual compensation. The document language makes it very clear that this applies to all eligible participants. What you are describing is a true-up that only applies to those over the 401(a)(17) compensation limit.  Like most things in this business, it boils down to "what does the plan say?" 

The difference between true-up and no true-up can also affect those under the compensation limit.  The easy way to avoid those issues is to use a true-up. 

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True, Kevin, that the last section of that IRS webpage refers only to elective deferrals.

However:

- It doesn't make any sense that the IRS would insist (unless the plan document clearly requires otherwise) that elective deferrals may continue after the first $280,000 of compensation has been earned but that matching contributions have to stop.  They both are contributions that (in the case of a match without a true-up) are allocated during the year after each payroll period.  There's no logical reason why it should play out differently for the matching contributions, why the IRS should require that deferrals continue to be made but that they can no longer be matched.

- The only example concerning matching contributions shows the employee Mary receiving the full match, not having her match cut off at the point when she earned $280,000.  Of course, the example isn't very clear given that it doesn't say whether the match is allocated each pay period, annually, or each pay period plus annual true-up.

Although we disagree to some extent, we agree that clear plan document drafting should address this.  For example, Fidelity's basic plan document has a paragraph at the end of the Compensation definition addressing this.

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Agree with MWeddell. For there to be a problem the plan would have to say that the match cap is calculated based on comp up to a separate portion (e.g, 1/24th) of the comp limit each pay period, which is a rare to nonexistent plan provision, I think. If your plan says you match, e.g., 100% of deferral up to 6% of comp, and (a) the "Compensation" or "Eligible Compensation" definition (as referenced in the match formula) is just the usual "W-2 with adjustments, limited by 401(a)(17))," or the like, and(b) the participant's deferrals are adequately spread out to capture the maximum match, then the fact that the participant may reach the 401(a)(17) limit before hitting either the 402(g) limit or the maximum match isn't going to stop them from getting the maximum match later, even without a true-up, because the "compensation" plugged into the formula is in effect annual comp.

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We had this exact issue with a payroll service that stopped the match as soon as the participant hit the comp limit, even though the document did not have such a limitation.  It required a response from an ERISA attorney and a letter of instruction from the plan sponsor for the service provider to "modify" their system.

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You are both assuming that the OP's document contains language that addresses the issue, but I read the original description as saying it doesn't.  I would be surprised if the document doesn't address it, unless perhaps the document was provided by a payroll company.  The bottom line is that you have to allocate the match the way the document says it is allocated.

The problem formula would be one that provides that the match for each pay period is determined solely by deferrals and compensation for that pay period, with no exceptions.  With such a plan, once you have used $285,000 of compensation to determine match for 2020, how do you allocate additional match to that person for 2020?  If you use compensation for a later pay period, you are using compensation in excess of $285,000 to determine the match.  If you consider compensation for prior pay periods, you aren't following the terms of the plan.

I always recommend to clients that their document have the match be determined based on the plan year. Our VS document gives the employer the option of depositing it during the year.  For those who deposit during the year, we true-up the match each time the match is calculated. If you don't use some sort of true-up, then two people with the same compensation and the same deferrals can have a different match depending on the timing of their deferrals.

 

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Kevin C,

I am assuming that the plan document is silent about this level of detail.  Like you, I would prefer that it be better drafted.

Based on the IRS page that you linked, there will be deferrals in every pay period.  Just as crossing the $285,000 earned so far during the plan year threshold didn't stop the deferrals, it shouldn't stop the match.  There is no reason to reach a different result for one contribution source compared to another.

My clients have a variety of plan designs.  Nearly all employers have matching contributions but only about half of them have a true-up feature.  I generally recommend a true-up feature when we have plan design discussions.

A slight quibble with the end of your post:  a true-up feature eliminates much but not all of the difference with match amounts varying based on the timing of deferrals.  Suppose A and B are employees eligible for a 100% match on the first 3% of pay, both earn the same compensation, and their compensation is completely level during 2018-19.  The plan  year is the calendar year.  A contributes 4% starting 1/1/2018, suspends contributions starting 10/1/2018, and resumes contributing at 4% starting 4/1/2019.  B contributes 4% starting 1/1/2018, suspends contributions starting 1/1/2019, and resumes contributing at 4% starting 7/1/2019.  With a true-up match feature, A will receive more matching contributions than B will.  This kind of distortion was more likely to occur when there were 6-month suspensions for hardship withdrawals.

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20 hours ago, MWeddell said:

Based on the IRS page that you linked, there will be deferrals in every pay period.  Just as crossing the $285,000 earned so far during the plan year threshold didn't stop the deferrals, it shouldn't stop the match.  There is no reason to reach a different result for one contribution source compared to another.

I don't think we are ever going to agree on this.  The preamble to the final 415 regs addressed the issue with deferrals:

Quote

As noted above, the final regulations provide that a plan cannot take into account compensation in excess of the section 401(a)(17) limit. In addition, the final regulations provide that elective deferrals can only be made from compensation as defined in section 415(c)(3). However, in applying these two rules, a plan is not required to determine a participant’s compensation on the basis of the earliest payments of compensation during a year.

I read that as confirming that the participant's deferral election can apply to compensation amounts in excess of the 401(a)(17) limit.  But, it doesn't say the same thing about the match.  The plan document's match formula will say which compensation is used to determine the match.  If you use compensation in excess of the 401(a)(17) limit to calculate the match, you have violated 401(a)(17). 

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If you are calculating the match on a payroll basis (don't confuse calculation with deposit), then you will never use compensation over the limit, unless the pay for that period is in excess of $285,000 (I want that job!). If the comp did go  over the limit that pay period, you should restrict the compensation to the limit for that pay period.

Also, it is good policy to put match caps in place in your payroll system.  If it's dollar for dollar up to 5% of pay, you instruct the program to cap the match at $14,250.

If you are calculating the match on an annual basis, then you are already (or should be) capping the formula with the max comp.

Kevin, what would you do in the case of someone who makes $$600,000 a year and decides to put in her deferral in the last payroll of the year, or out of the late-September bonus check?  Does she not get the match b/c she passed the cap sometime in July?

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QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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