401(a)(17) and calculation of match

[Guest APierce]

Based upon informal IRS guidance, we know that 401(a)(17) does not prevent elective deferrals on compensation in excess of $200,000. My question relates to the application of 401(a)(17) to the calculation of a matching contribution. Assume that the plan provides that the match shall be equal to 50% of the first 4% of elective deferrals (expressed as a percentage of Plan Compensation). The plan clearly provides that for all purposes other than determining elective deferrals, Plan Compensation is subject to the 401(a)(17) limit. Assume, for the sake of simplicity, that the match is determined on an annual basis.

An employee with an annual Plan Compensation of $300,000 defers at a constant 4% rate throughout the plan year. 4% of $300,000 is $12,000. Under one interpretation, the employee is entitled to a $6,000 match (50% of his elective deferrals up to 4% of Plan Compensation). This interpretation assumes that when calculating the deferral percentage subject to the match, you need not apply the 401(a)(17) limit (i.e., $12,000 is 4% of $300,000).

On the other hand, since we are calculating a matching contribution, I am wondering if the 401(a)(17) limit should be applied to limit Plan Compensation in the matching formula to $200,000. Under this interpretation, the employee is entitled to a $4,000 match. This assumes that when calculating the deferral percentage subject to the match the 401(a)(17) limit applies ($12,000 is 6% of $200,000). The first 4% of Plan Compensation limited to $200,000 is $8,000, resulting in a $4,000 match.

Any thoughts on which is the proper intrepretation?

[R. Butler]

For purposes of the match you can't consider compensation in excess of the 401(a)(17) limit. Based on the scenario you set forth the match would be $4,000.

[david rigby]

Not sure about the interpretation, but you probably have a problem with plan drafting.

[Guest APierce]

Thanks for the reply Pax. Could you elaborate on why you think there might be a drafting problem?

[david rigby]

If the goal in this situation is that the participant should get a $6K match, then defining the match are related to comp is what causes the problem. Why not define it as 50% of the deferral?

[Guest Giovanni]

Also, in this case, could design the plan with a match of 50% of 6% and then the match would still be $6,000. This way, you won't have to match deferrals in excess of 6% for others if the company is not that generous.

[JDuns]

Most plans I have seen do not distinguish in the comp definition between the maximum comp for deferrals and the maximum comp for other plan purposes.

If (as with most plan documents I have seen) the compensation definition is the same for both types of contributions and the plan document uses the same language (a participant can defer 1% to 15% of Compensation and participant will receive a match of 100% for the first 3% of Compensation deferred) I believe that the plan must either both allow the deferral and match ($12K deferral and $6K match in the example above) or cut off both ($8k deferral and $4k match).

Only where the plan document specifically distinguishes the compensation definition can you reach a $12k deferral and $4k match (which I believe would be the correct interpretation under such drafting).

[R. Butler]

JDuns,

If (as with most plan documents I have seen) the compensation definition is the same for both types of contributions and the plan document uses the same language (a participant can defer 1% to 15% of Compensation and participant will receive a match of 100% for the first 3% of Compensation deferred) I believe that the plan must either both allow the deferral and match ($12K deferral and $6K match in the example above) or cut off both ($8k deferral and $4k match).

Maybe I misunderstood your post, but if the match rate is 50% on the first 4%, the maximum match that a participant can receive is $4,000. The 401(a)(17) comp. limit is $200,000.

When you really think about it, the comp. limit is $200,000 for all money sources, including deferrals. (That is not to say you can only defer off the first $200,000 you make.) If the document limits deferrals to a specified % of compensation, you cannot consider compensation in excess of $200,000. The ADP test, only considers comp. up to $200,000; your top-heavy ratios, only comp. up to $200,000 is considered. You cannot consider wages in excess of $200,000.

[JDuns]

My post was intended to point out that - unless the plan language limits comp to the 401(a)(17) limit for all comp except deferrals (as stated in the original post) - the plan must either cut off both the deferral and the match when the employee hits $200K or neither the deferral nor the match.

Interpreting the plan one way for deferrals (allowing the employee to defer 4% of $300,000), the plan would need to match 50% of all of the deferrals ($6,000 total match) rather than matching only on the deferrals attributed to the first $200,000 of compensation (so matching only $4,000).

[Harwood]

Edited excerpt from Q&A 26, 2002 ABA Joint Committee on Employee Benefits & IRS Officials. http://www.abanet.org/jceb/2002/qa02irs.pdf

Q: An employer maintains a qualified cash or deferred arrangement on a calendar-year basis and stops all further contributions once a participant's compensation exceeds the §401(a)(17) compensation limit. . . .

IRS response: . . . The IRS noted that such a limit on deferrals would be considered an employer-provided limit, since neither §401(a)(17) nor the regulations thereunder would require suspending elective deferrals solely because the participant has received wages equaling or exceeding $200,000.

[david rigby]

From Gray Book, Q&A 1999-30

In a 401(k) plan, does IRC Section 401(a) (17) preclude the following?

A. Employee A earns $300,000 annually. He enrolls in 401(k) calendar year plan in August, after earning $175,000. He defers $10,000 for the balance of the year.

B. Employee A earns $300,000 annually. He participates in a calendar year 401(k) plan making monthly deferrals of a flat dollar amount of 1/12 of $10,000 in 1998, even though his pay exceeded $160,000 before he was done making elective deferrals.

C. Same as B, but deferrals are a percentage of pay (3.33333%).

RESPONSE

All of the above are acceptable, assuming the plan is not drafted in such a way as to prevent it. In situation C, for example, a plan provision permitting deferrals expressed as a percentage of compensation but not permitting deferrals expressed as a dollar amount could not accommodate deferrals on pay in excess of $160,000. Where the plan permits deferrals expressed as a dollar amount specified in the employee's salary reduction agreement, the reference to a percentage in the individual agreement is irrelevant.

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[R. Butler]

I do not disagree that a participant can defer on paychecks that total more than $200,000. However, if the match rate is 50% on the first 4% of deferrals, the highest possible match that a participant could receive is $4,000. The partcipant could not ever receive a $6,000 match regardless of whether that participants deferred on paychecks that totaled more than $200,000. Allowing the participant to receive $6,000 match on a 50% of the first 4% formual violates 401(a)(17).

[Guest pjb]

The ERISA Outline book seems to disagree with the Gray Book:

"So long as any limitation placed on the participant's deferrals for the year is based on compensation that does not exceed 401(a)(17), it does not matter whether the participant makes that deferral over a portion of the plan year in which he earns no more than the 401(a)(17) limit, or over a period in which he earns in excess of that limit. Thus, the employee deferral of 5% of compensation until $11,000 deferral limit is reached, would not violate 401(a)(17), even though deferrals are being withheld from paychecks totaling $220,000."

However, if there is a plan imposed limit, you would need to stop deferrals once a participant reaches the plan imposed limit during the plan year (based on 401(a)(17) comp limit). Otherwise, the plan would need to distribute the excess at plan year end.

[R. Butler]

Where do you see a difference between the ERISA Outline book and the Gray Book?

[Guest pjb]

Isn't the Gray book saying the plan would need to stop deferrals upon attaining the comp limit during the year if the election is in the form of a % of pay?

[R. Butler]

I don't think so. I interpret their explanation on Answer "C" to mean that if the document limits deferrals to a % of pay then you couldn't defer on wages in excess of the 401(a)(17). If you continue reading in the ERISA Outline book, I'm sure it will say the same thing.