401(a) or Annual Compensation Limit

[Guest hwilliams]

We have a number of highly compensated employees that reach the $205,000 compensation limit fairly early in the year. These employees are encouraged to keep their contribution percentages fairly low so that they can receive the maximum benefit of the employer match (we use the safe harbor matching - 100% of the first 3% and 50% of the next 2%). The problem is that these employees will probably never get to the $14,000 annual contribution limit doing this. Our benefits director is asking whether or not this is just the way it is or if there is something that can be done to allow these employees to still contribut the maximum contribution amount but still take advantage of the employer match. Should we offer after tax contributions once the compensation limit is reached? Any other suggestions?

Also, excuse my ignorance, but the 3 limits (401(a)/annual compensation, 402(g)/maximum contribution and 415©/annual defined contribution limit) apply to all and every 401(k) plan and participant regardless of how the plan is designed, correct? Safe Harbor plans are not exempt? Thank you.

[JanetM]

You are correct. The limits apply to every plan and every participant. To get around this problem we added flat dollar contributions. For example an HEC can do $583 per pay. This amount for 24 pays gets them to $13,992. Of course most get a bonus or two. So they just figure the number of pays they have and then do the math.

[QDROphile]

Don't stick yourself with a rigid payroll period matching system. You already see the disadvantages and unfairness. Change to a system that either matches at the end of the year or trues up the match at the end of the year to take into account all deferrals during the year.

[Guest hwilliams]

Thanks. On the second option, I don't see how that would help us since the problem is reaching the compensation limit of $205,000 not the contribution limit of $41,000. They simply reach the compensation limit too quickly to contribute up to the $13,000 401k limit. Besides, our payroll system does the match automatically each pay period, we have to report that to our administrator and our employee population to large to do some kind of year end, manual calculation.

I might have to test the first option but I would think we would still run into the same problem since sometime in October/November these employees will reach the $205K limit ($210 for '05). Do you figure out the number of pay periods until they reach the compensation limit and then divide the contribution limit by that?

[stephen]

hwilliams,

Your third party administrator should be able to do the matching calculation for you. Of course this assumes you are using a TPA for your plan.

[david rigby]

As QDROphile has implied, you need not be bound by your payroll system. The mechanics of payroll deduction should permit a "true-up", thus permitting participants to reach the 402g limit.

Also, check plan provisions carefully; it is possible prior administration (that is, limiting the deductions) has not been in accord with the plan document.

[Guest hwilliams]

Thanks again. I think I am getitng it but let me run a scenario by you to make sure I understand.

Say an employee earns $250K/year in 401k eligible earnings. They would normally contribute at 6% to maximize the match through the year. However, with the comp limit, this will get them to the 2005 $210K limit somewhere around late October thus stopping the contribution and the match. What is suggested here is that we do not do the match in the system and have the employee contribute say 10%. They will reach the 2005 $14K contribution limit sometime in the middle of the year BEFORE reaching the $205K comp limit. Then at year end, the TPA figures the employer match (max 4% for the Safe Harbor) and contributes that to the balance?

My only concern on that is that the employee is not getting the match contributed to the 401K throughout the year and thus not investing those funds, receiving returns an so forth. Couldn't we still do the scenario above with the system calculating the match as we go?

[stephen]

Yes, you could have a plan design that allows for a match true up throughout the year.

[QDROphile]

I perceive in your comments a possible fundamental mistake. Reaching compensation equal to the 401(a)(17) limit ($205,000 for 2004) during the year is no reason to stop deferrals or matching contributions related to the deferrals. Only an incredibly stupid plan design would would do that. If the matching formula uses a percentage of compensation as a factor, the number for the compensation cannot exceed the 401(a)(17) limit, but that is a very different matter. The 401(a)(17) limit is not a timing rule. This issue has been discussed in several other posts. You may wish to search and find them.

[Guest hwilliams]

Ouch. Thanks for the stupid comment. OK, I was just doing as our payroll department defined with the match stopping and as our payroll system defined with the contribution stopping. Actually, the way I had it set up originally would continue the match once a limit had been reached, but our payroll manager said that was incorrect. But I did think the 401(a)(17) limit was designed to limit the deferral amount at some point. This is the way PeopleSoft (a major payroll system) has designed it. Again, I plead ignorance as I am a system person trying to get the system to work the way the business people want it to.

I will see what I can find searching.

[QDROphile]

I did not say you were stupid. You may be uninformed, but uninformed is vastly different. And you did not design the plan. But back to the stupid comment. Are you sure that your plan terms say to stop deferrals at the 401(a)(17) limit or is that the uninformed interpretation of someone? I would be concerned that the plan is not being administered in accordance with its terms. Never trust payroll people. They have agendas that are incompatible with benefits. Of course it is easier simply to turn of the system when the compensation counter gets to the 401(a)(17) number.

The 401(a)(17) limit cannot limit deferrals (absent stupid plan design) because deferrals are limited by 402(g) before the 401(a)(17) amount becomes a limiting factor. 401(a) (17) defines the largest number that can be entered as compensation in a formula that defines benefits as a function of compensation. Test its effect under your formula for the match, but be sure to assume true compensation for the individual that is a bigger number.

[Guest hwilliams]

No, I don't think the plan design DOES limit the contribution. The PeopleSoft system does. We only have certain earnings that contribute to the 401k eligible earnings - regular, retro, vacation, sick, holiday, jury duty, bereavement and commissions. The affected employees are all executives that most of their earnings would be in the regular category and they reach the $205K around this time of year. The system has the 3 limits set up and when an employee reaches one of the 3 limits, it stops the deferral and match. We have a handful that reach the 402(g) and the 401(a) but I have not seen one ever get the 415© simply b/c it is impossible due to the matching.

I guess I do not understand the true function of the 401(a) limit then. If the limit is not designed to stop deferrals/match at a certain point, then what does it do?

[Tom Poje]

the comp limit (in this particular case = 205,000) is used for

1.testing purposes. eg ee defers 13,000, so for ADP test his percentage is 13,000 / 205,000 not 13,000 / 1,000,000 if that is how much comp he actually had.

2. if plan makes profit sharing contribution that will also be based on 205,000 not something larger.

if it helps, pretend you get one paycheck at the end of the year, and you defer only once. at that point in time you limit the comp to 205,000.

by the way, and I dont think it was mentioned, or maybe not clearly, the plan could allocate a match on a payroll basis. further suppose the individual defers 13,000 the first payroll with comp of 26,000, simply because he wants the earnings for the whole year. A whopping 50% of pay. if match was limited to 100% of the first 6% deferred, he would receive a small match, and there would be no true up of the match during the rest of the year because he had no more payroll deferrals..

[QDROphile]

For purposes of Tom Poje's message, a matching contribution is a profit sharing contribution.

Also, the payroll matching arrangement that he describes is usually something that people like to avoid because of the obvious unsatisfactory results. I am surpeirsed at how many plans do it that way out of ignorance or having a payroll system override better judgment.

[could be me maybe not]

FBO those who may live in ivory towers, in the uninformed stupid world, sometimes the payroll system comes first, then the HR person responsible for the 401(k) plan, then the 401(k) plan. And sometimes the HR person does not have the clout to get a payroll system replaced away.

[david rigby]

True, but the comments are not meant to imply replacing a payroll system, just using it properly, and in accord with plan provisions. Too many seem to treat the latter as a nuisance.

[Guest hwilliams]

But this is PeopleSoft. A multimillion dollar payroll software chock full of regulations and such. For the most part it works really well. There are only a few things (like this) that I question. The regulatory requirements are set up by PS, not by me. I am trying to figure out if the system is working right or not based on the requirements. I am checking with them as well now that I know the requirements but thought here would be a good place to get the regulation straight.

[could be me maybe not]

Right. You did the right thing. You just got a few too many "drinks thrown at you" unnecessarily in the process, IMO.

[Guest Donkey Kong]

Me eat people(soft)!!!

BTW, if you say IMO, then you are a bragger. It should be IMHO, but are you humble? I think we all know the answer is NO!

[could be me maybe not]

Nice picture, IMHO.

[QDROphile]

My only invective related to a possible plan design, and the plan designer is not particpating. Being uninformed is neutral. Ignorance is the beginning of knowledge. Remaining uninformed in light of a need for information is not so good, but that is not what is happening here. Differences between payroll agendas and benefits agendas does not mean that one or the other is superior, but it is important to recognize the differences and find a way to accommodate needs to the extent possible rather than have one steamroll the other. So where are all those drinks coming from?

[could be me maybe not]

Had to look it up. Googled "invective". Learned two things. (1) How many others knew that invective was word of the day on March 19, 2001. (2) Now I know what vituperation means.

Credits to dictionary.com

in·vec·tive ( P ) Pronunciation Key (n-vktv)

n.

Denunciatory or abusive language; vituperation.

Denunciatory or abusive expression or discourse.

adj.

Of, relating to, or characterized by denunciatory or abusive language.

--------------------------------------------------------------------------------

[From Middle English invectif, denunciatory, from Old French, from Late Latin invectvus, reproachful, abusive, from Latin invectus, past participle of inveh, to inveigh against. See inveigh.]

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invective

invective was Word of the Day on March 19, 2001.

[Guest srs]

We have a number of clients with Peoplesoft systems (and other systems) that "true up" the match with each pay period, so I don't think Peoplesoft is the problem.

You calculate the match based upon YTD comp, deferrals, and match (what the match "should be" at end of pay period minus YTD match of the preceding pay period) rather than on the pay period's data only. This effects all employees, not just those at the 402(g) / percentage deferral "problem". As a result, it costs the company a higher match each year, so you would want to calculate the impact on company financials. This is because you will have lower paid employees who defer % less than the match's deferral limit early in the year, but raise it later in the year over limit, and if you true up as you go, they will cost hard dollars over and above what it takes to fix the employees over the comp limit. Alternatively, I have seen attorneys draft documents that only true up for those employees that reach 402(g) limit but no others have a true up. In that scenario, you let the high comps (or anyone else who defers 402(g) max without a maximum match - front loaders) defer to the 402(g) limit anytime in the year (you see people max 402(g) in first January pay period) and either at the end of the year (normally what I see) or in subsequent payrolls, you true up only those at limit.

To true up each payroll period can be done in 1 formula, but the steps are:

Calculate deferral for pay period

Lookup maximum YTD deferral, limit by 402(g), 13,000

Take the lesser of two for pay period (this gets them to 13,000 even)

Calculate eligible compensation for pay period (if have exclusions in plan)

Add to prior pay periods YTD eligible compensation

Lookup maximum YTD compensation to consider, limit 401(a)(17), 205,000

Take the lesser of two for YTD eligible, limited, compensation (this gets them to 205,000)

Calculate match based upon YTD eligible comp and YTD deferrals minus YTD match at prior pay period, or:

If YTD deferrals > YTD eligible limited comp * Maximum deferral % for match, then:

YTD eligible limited comp * Maximum deferral % for match * Match rate, otherwise:

YTD deferrals * Match rate

Then you take match above and subtract YTD match in prior pay period to equal this pay period's match.

This replaces the entire match calculation, you don't need a separate one for those not at a limit...it will calculate a straight 50% match for those not at either 205,000 or 6% limits. If the plan only true's up those at 402(g) limit, use the above for those at 13,000, use existing formula for all other employees.

If a plan has a 50% match rate and maximum deferal % for match of 6%, the participant at 205,000 and 13,000 deferrals should get 6,150

Make sure the match calculation doesn't sort out people without a deferral for the pay period in the programming, the population needs to be all eligible employees with compensation in the pay period. What you would see if you have someone paid monthly who makes $20,000 per month and defers all 13,000 in the first monthly pay period is that they will get a $600 match in January, in February you'll withhold 0 deferals, since at limit, but will get a $600 match, this will go on to November, when they'll get a $150 match.

You'll also see those employees deferral less than 6% early in the year, but then deferring more than 6% later in the year get more than a 3% match in those later pay periods. (that's the additional cost referred to above)

[Guest AVH@MLS]

I've run into the same situation with our SAP payroll system. In the last two payroll weeks a few executives' deferrals suddenly stopped, even though they were under the $13K limit. The system stops deferrals once the benefits salary reaches $205K or the employee defers $13K...whichever comes first. I initially thought this was a configuration issue on our part, however drilling down into the help screens shows this is standard configuration on SAP.

Basically we want the employer match to cap at 4% of the annual salary limit ($8,200) and the employee contribution to stop at $13,000. Sounds reasonable, huh? However, neither we nor our highly paid consultant can find an easy way to configure this. As a temporary fix we've taken off the $205K benefits salary limit, however that caused the employer match to continue. Now we are manually deleting the match amount...

Anyway, I want to thank you all for these posts - I searched a few other web sites and none had the clarity or decisiveness I found here.