Deferrals from Cafeteria Plan

[rcline46]

Company sponsors a 401(k) plan and has a cafeteria plan. Company funds the cafeteria plan at $300 per month for all eligible employees. Employees can choose from a menu of benefits on which to spend their $300.

The plan provides that any unspent money will be contributed to the 401(k) plan as an employee deferral. There does NOT appear to be a cash option. I am waiting to get a copy of the document.

My questions are:

Is this really a deferral if there is no cash option, or is the deferral treated as a cash option? If not a deferral, then what is it?

The document calls for the addback of all deferrals to compensation used for benefits and testing. Does this get added back also since it is on the W-2?

If the leftover 125 money gets added to compensation, does this cause ALL of the employer 125 contribution to be added back?

Please provide any cites so I can see where I missed the rules.

Thank you.

[QDROphile]

You can't have an elective deferral under a 401(k) plan without a cash option. You can have a section 125 arrangement without a cash option, but there must be some taxable option (cash is usually the taxable option).

You might be able to design a retirement plan to pick up the unused welfare benefit amount, but it would not be a 401(k) elective deferral contribution. I would not attempt such a design.

The additions to compensation testing purposes usually cover all the amounts that would have been included in taxable income but for an election to reduce pay under 401(k), 125, 132(f)(4), 457. I am confused by the phrase "defrrals to compensation."

[rcline46]

Prior to the Final 415 regs, 415 comp did NOT include deferrals, and so by using the 'addback', deferrals get added back to 415 compensation. (Note - this is no longer true under 415 - deferrals ARE included in 415©(3) comp) So, 401(k) and 125 deferrals were added back to 415 comp in the document.

My problem, as you noticed, is that these 'deferrals' were/are leftover corporate 125 contributions and are NOT employee elective deferrals. When these funds were put into the 401(k) plan, they were classified as deferrals and became taxable income on the individual's W-2. I am trying to sort through the situation (and I need the document to verify how the plan worked) and determine if I really have 'deferrals' or if not, what the heck the contribution is since the employee was taxed on it (ok, taxable income reduced by the 'deferral')

[rcline46]

Returned this to active posts. Still do not have the document. Any other ideas as to whether this is really compensation in the 415 sense, or is it taxable income but not 'compensation'?

[Guest nherkowitz]

i've seen a number of cafeteria plan designs that do this, and inevitably most of them design it incorrectly.

My understanding is:

1. If there is no option to take the unused cafeteria plan money as compensation, then there is no salary deferral. This is a qualified plan regulation, not a cafeteria plan rule. This makes sense, as you can't defer salary that you have no option to receive.

2. If these contributions are mentioned in the document, the contribution(s) to the 401(k) plan from the Cafeteria Plan, are likely to be considered employer discretionary profit sharing contributions. This would require general discrimination testing along with any other employer discretionary PS contributions.

3. A big problem is if the allocation method in the document does not provide a specific contribution allocation to the individual who forfeited the money from the cafeteria plan. Most plans require an contribution allocation based pro-rata on compensation, which won't work here.

[CTipper]

EBIA used to have a very nice explanation of this in their Cafeteria Plan binder. (I think they've been bought by someone and I can't remember the new name right now.)

From the cafeteria side of this problem, the employee must have some form of "cash back." If there's no opportunity to prevent constructive receipt, there's no cafeteria plan.

Just for giggles let's assume that the employer spending credit is $300 per month and the employee elects to run $200 of that through medical reimbursement in the cafeteria plan. Okay, that part's clean.

But now the employee has chosen to NOT prevent constructive receipt of $100. For purposes of this discussion, let's not worry about any cafeteria plan provisions reducing the amount of cash back based on how they choose to use or not use it. Further, let's assume that this employee has checked off on his enrollment form that he wants the $100 to go to his 401k plan account.

The employer then adds $100 per month to his W2 wages and defers $100 in salary deferrals. Yes, the employer is then actually paying $107.65 for a $100 benefit (FICA, etc.), and the employee is paying $107.65 for a $100 contribution to his 401k. $7.65 to FICA, etc., and $100 to his 401k plan.

The existing 401k plan covers this already. Right? The 401k plan handles W2 compensation and deferrals.

What document are you waiting for?

QDROphile, why are you saying you can't do this in a 401k plan? Final cafeteria regs from 2000 or 2001 specifically mention and allow employer spending credits to go to a 401k plan. In fact, they're written in such a way that they're only allowed to go to a 401k plan. 403(b), 457, Sar SEP and Simple IRA are exluded. I've never been asked, but I've always assumed that Simple 401ks were included.

The messy part about this is operational -- not plan documents or testing.

The employer needs to remember to add the unusued employer spending credits to compensation.

The employer and employee need to understand that FICA is still involved.

And, finally, most of the cafeteria plans I've seen have a much shorter waiting time to get in than the corresponding 401(k) plan. So, until that participant has satisfied 401(k) plan eligibility -- or the 401k plan eligibility is changed to coordinate with the 125 plan -- the participant has to have some other cash back option.

What's going to be interesting is how this ties in next year with the automatic enrollment and the 90 day free look. Although I've seen nothing written on this, I presume that this wouldn't really be a default automatic enrollment from the 401k plan's point of view because the participant has done something actively to get a 401k contribution.

that help a bit?

Christopher