Match and First $205,000

[Guest CMcCull]

I'm a personal finance/tax guy with a client whose employer is telling us that even though he elected to begin deferals into the 401k in August, he will be receiving no match in 2004 since he had already earned $205,000 before his deferal election became effective. Company is saying that he can defer, but he gets no match.

"There is a legal stipulation by the IRS that you can only contribute for the first $205,000 that you earn to get the company match."

Doesn't seem right to me. Any thoughts?

[Appleby]

Sounds odd to me. $205,000 is the compensation cap for 2004. The compensation cap rule is that compensation in excess of $205,000 cannot be considered for plan purposes. For instance when determining an individual’s allowable contribution to the plan, even if that individual earns $300,000, only $205,000 can be taken into consideration.

You may want to check the plan document to determine the plan’s definition of compensation.

I recall that compensation for plan purposes can be limited to that earned while the individual participated in the plan (compensation earned before the entry date can be ignored) in some instances, but the rule you explained sounds foreign to me … but I am no 401(k) expert, so let’s see what others think.

[rcline46]

They are wrong, and cannot provide any cites to support their position.

Since they are the ones denying benefits, they must provide the cites to support their position. Take a look (do a search) on previous threads concerning compensation for deferrals and matches. Very enlightning.

[MWeddell]

This is not the most optimal way to enforce Code Section 401(a)(17)'s limit on compensation but I don't know that I would call them wrong. What seems bizarre to me is the inconsistency: letting participants continue to defer but not allowing them to earn the match. I've got some clients who use Fidelity (the recordkeeper with the largest U.S. market share) who do this and I just don't get it.

Consider using the plan's claims appeal procedures to get past the gatekeeper and have the issue seriously considered by the plan administrator.

[Guest Harry O]

It is not necessarily wrong. It is a very rigid way to enforce the 401(a)(17) limit but some administrative systems are not very flexible. Bottom line -- it depends upon what the plan document says.

[david rigby]

Right? Wrong? Most likely, this is not what the the plan says.

[Guest 401der]

The 401(a)(17) limit is simply the highest number that can be used when calculating a contribution or benefit for a participant, regardless of when during the year it was paid as compensation. It isn't "the first $X paid", and rcline46 is correct that those who say it is can't give you a single cite to back that position up. The plan document probably won't be specific enough about this and more than likely simply refers to the 401(a)(17) limit, but if you read the language carefully, you will probably find that where the limit is applied is for purposes of an annualized calculation based on a compensation figure and that compensation figure can't be more than the 401(a)(17) limit. If the plan document provides for a match contribution calculated on a payroll or other non-annualized period, it could conceivably specifically state that no match will be made on deferrals that are made after a participant has earned his first $205,000 for the plan year, but my money says you won't find that language in the plan document.

[mbozek]

The law only prohibits using more than 205k in determining the amount of the contributions that can be made to the plan. However some systems can only enter contributions based on the first 205k earned which would require manual entry of the match. Need to check the plan to see how it is worded. Plan can limit contributions to first 205k earned in year.

[Bird]

If someone has approved plan language that limits comp to the FIRST $205,000, please share it with us; I for one would like to see how it is worded.

I just looked it up in Sal Tripodi's book and he addresses this specifically and says that comp is not limited to the FIRST $205,000 (page 3.172 if anyone cares). Now, that discussion was specific to deferrals, not matches, but I don't see how it could be interpreted otherwise for matches. The references were to The EP/EO Bulletin published by the IRS Western Key District Office, Summer 1997 Issue, Q-2. and the IRS Q&A session (Q&A-59) at the 1999 ASPA conference.

I have the ASPA conference Q&A and can type it out if you need it. Let me know.

[Bird]

Oh heck, here it is:

59. In a 401(k) plan, does 401(a)(17) preclude the following:

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

B. 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 2, but deferrals are a percentage of pay (3.33333%).

(IRS response) We believe that all three scenarios should be OK. This will be discussed additionally from the podium.

Again, I understand that this doesn't specifically address matches but I can't see how you would treat them differently. Their inconsistency in allowing the deferrals but not matching is indeed bizarre as MWeddell noted.

[david rigby]

If you are keeping score, that is Q&A30 from the 1999 Gray Book, but the complete response is:

"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."

Here is the appropriate copyright information:

Copyright © 1999, Enrolled Actuaries Meeting

All rights reserved by Enrolled Actuaries Meeting. Permission is granted to print or otherwise reproduce a limited number of copies of the material on the diskette for personal, internal, classroom, or other instructional use, on the condition that the foregoing copyright notice is used so as to give reasonable notice of the copyright of the Enrolled Actuaries Meeting. This consent for free limited copying without prior consent of the Enrolled Actuaries Meeting does not extend to making copies for general distribution, for advertising or promotional purposes, for inclusion in new collective works, or for sale or resale.

[jquazza]

If the document is drafted to only include the first 205k, then the particiapnt should not be able to defer. It seems to me that the service provider is not consistent. How can he have compensation to defer but not to get matched?

[rcline46]

I will have to research it, unless someone else knows - but the IRS has pulled back on the 1999 statement because it was proven they were in error. Need to look at a later question!

Have to wait a bit afore I have time.

[rcline46]

Haven't researched the Q & A's other than in prior posts, but also consider -

The position I take is first, if you are nervous then you can be conservative and word your deferral as fixed $ and avoid the issue. I have no problem with that.

Then, if you can say x$ per pay, then since that is convertible to a %, they are equivalent, so stating a % is mathematically no different than stating a $ level.

The second arguement is that a salary deferral agreement is between the employer and employee. It is not a part of the plan document, is not included in the 4 corners of the document, is not an attachment or addendum to the document, and in fact may contain such items as 125 reductions, non-qualified plan deductions and other items not involved in the qualified plan. Therefore the items on the SDA need not conform to language in the document. (Side note - a matching contribution IS a plan issue!) You will find no definition of an SDA in ERISA, only that deferrals must come from a valid SDA.

Third part is exactly what you said, but I will emphasize and annotize -

The PLAN (does not say SDA) shall not take into account compensation in excess of $200,000 (indexed) (recognizes that other non PLAN operations may use comp over $200,000).

Therefore, any calculations in the plan - defined benefit formulas, money purchase or profit sharing calculations, matching contributions - these must all limit the compensation to the 401(a)(17) limit. An employee deferral is NOT computed by the plan, ever. The plan may set limits, as does 402(g), but just what does the plan limit really say? It says ON AN ANNUAL BASIS the contribution cannot exceed some % of pay (and yes this pay is the 401(a)(17) limit). You just cannot turn this around and say you must stop deferrals when you hit the annual pay limit - that is backwards! Ignoring 402(g), you cannot determine this answer UNTIL you have reached the end of the year. Only at year end can you determine if the deferrals have exceeded the plan limit.

Let's see what happens if you try to test at mid-year - when PAY reaches the limit. The employee has not yet reached the plan limit. You are now prohibiting the employee from reaching the limit. Under what authority are you limiting their ability to reach the plan limit? I see not authority for that limitation in the plan.

Is there any need to continue this?

[Bird]

CMcCull, do you have any feedback? I think we'd like to know how this turns out. Also would be curious to see if the administrator can provide a cite in the plan showing that only the first $205,000 is matched.

[Guest CMcCull]

Thanks to all!

I should have a copy of the plan document today or Monday; I'll post the specific language related to Matching from the doc.

[Guest CMcCull]

As promised last week, the Plan reads:

A Participant who is an Eligible Employee may make Pre-Tax Contributions as provided in this Section. An Eligible Employee may enter into a written payroll reduction agreement on the Application Form with his Employer agreeing to contribute Pre-Tax Contributions to the Plan of a specified whole percentage, from one percent (1%) to twenty percent (20%) of his Base Salary each pay period.

Addtionally:

"Base Salary" for a Plan Year means the compensation, as defined in Treas. Reg. 1.415-2(d)(10), a Participant received from his Employer in the Plan Year after the Participant commenced participation in the Plan. To the extent required by Code Section 401(a)(17), the compensation of a Participant for any year taken into account under the Plan shall not exceed One Two Hundred and Five Thousand Dollars ($205,000)(as increased by the Cost of Living Adjustment for the year).

Matching:

Each pay period, each Employer shall contribute on behalf of each Participant employed by such Employer a Safe Harbor Matching Contribution equal to one hundred percent (100%) of the amount of such Participant's Pre-Tax Contributions and any applicable Catch-Up Contributions that do not exceed three percent (3%) of the Participant's Base Salary per pay period, plus fifty percent (50%) of the amount of the Participant's Pre-Tax Contributions and any applicable Catch-Up Contributions that exceed three percent (3%) of the Participant's Base Salary per pay period, but that do not exceed five percent (5%) of the Participant's Base Salary per pay period.

Thanks again for your help!

[rcline46]

Ok, document says comp while eligible, so first $205,000 can't be true for anyone who starts other than Jan 1.

Second, document says cannot exceed $205,000 for the year. Nowhere does it say FIRST $205,000.

Match - calculated on a per pay basis AND limit not addressed in this section! So only ANNUAL limit applies. Not that the SH match cannot exceed $8,200 or the formula applied and summed by pay, whichever is lower.

Result - whoever said FIRST $205,000 is wrong as a matter of the document itself.

[Bird]

  Ok, document says comp while eligible, so first $205,000 can't be true for anyone who starts other than Jan 1.

Second, document says cannot exceed $205,000 for the year. Nowhere does it say FIRST $205,000.

Match - calculated on a per pay basis AND limit not addressed in this section! So only ANNUAL limit applies. Not that the SH match cannot exceed $8,200 or the formula applied and summed by pay, whichever is lower.

Result - whoever said FIRST $205,000 is wrong as a matter of the document itself 

That's how I see it.

[jquazza]

I suspect that you have a payroll company trying to impose its own system limitation on the administration of the plan in contravention of the plan terms.

If I was the participant affected, I would be fighting for my benefits.