401(k) elective deferral hierarchy

[Guest Thomas2006]

Employer has previously been pulling elective deferrals to its 401(k) plan from each participant's paycheck first (i.e., before pulling amounts for the cost of group health coverage, FSA contributions and child support payments). However, in several instances, an individual has not had enough money to pay the full premium for health coverage (or to make a full child support payment). Can the Employer alter the hierarchy such that 401(k) elective deferrals are pulled from a paycheck last? Thanks.

[Peter Gulia]

After first meeting any priorities required by Federal law and those State laws that are not preempted, it would seem that an employer could amend each relevant plan's governing document and summary plan description to state the ordering rules that the plan sponsor prefers. (Also, it would be smart for each salary-reduction form to include one sentence that mentions a "not-enough" rule and refer to the SPD.)

A related question: what do benefitslink readers think about what ought to be the desired order when a paycheck doesn't have enough money to meet all of the contributions that a participant elected?

[masteff]

Keep in mind that the following is just one opinion....

I remember some discussions that bordered on philsophical when setting up a heirarchy. First off, you have to leave child support and other court ordered garnishments at the top of the list (right after payroll taxes). After that it became a matter of what is for the best good of the "average" employee. When you start ranking needs, the need for health comes before the need for financial protection in the event of death comes before the need for retirement savings. So med ins > life ins > 401(k). Once we got to 401(k), we put pre-tax before after-tax and matched before loans before unmatched.

At my last job (4500+ employees), our plans were silent as to the order of deduction from payroll.... we simply established it as a payroll policy. Our order was something like:

Health & welfare deductions

Pre-tax qualified plan savings

Matched after-tax savings (availability varied by union plan)

Qualified plan loans

Other after-tax (like unmatched after-tax savings, United Way, etc)

Note: the other thing you have to decide is if a deduction goes into arrears or simply gets skipped. Things like FSA and qual plan loans should probably be carried to a future check. Whereas after tax savings might simply be skipped.

[GMK]

With the hope we never have this situation, but in the event we do ...

Is there any guidance on whether a 401(k) deferral can be reduced below the participant's elected level in a case like this?

Otherwise, it looks like the only other thing in this post that can be cut is the group health insurance payment.

Thomas2006, when this happens, what do you do now? Do you allow (or require?) the employee to make up the shorfall from other sources? next paycheck?

Any and all replies are appreciated.

[Peter Gulia]

A further question: If we accept the idea that a typical worker needs a welfare benefit with more immediacy than he or she needs a retirement benefit, what's the right priority among welfare benefits?

For example (assuming all health and welfare benefits are not insured and instead "self-funded" with the employer), should a worker prefer to lapse first his or her child-care "FSA" coverage, or health coverage? One is tempted to argue that maintaining health coverage ought to be more important than saving money to become able to pay a child-care provider. But some might argue that in the absence of child-care services the parent might become unable to keep his or her job and, even with an opportunity to pay COBRA premiums, the absence of a paycheck could result in an absence of health coverage and further losses to the family.

These choices aren't easy, and principled arguments might be made for a range of different ordering rules.

[JanetM]

masteff we use the similar hierarchy with couple changes.

Tax withholding and mandated garnishments

Health & welfare, FSA (medical and child care)

Union dues

Qualified plan loans

Computer loans (paid to company)

Other after-tax - United Way

Pre-tax qualified plan savings

After-tax savings

Logic being that you should be meeting contractual (loans and pledged charitable contributions, dues, required premiums for coverage, FSA amounts) before those discretionary pre and post tax amounts.

This way the required H&W plans stay in effect, the loans and pledged obligations are met and only the employee misses out.

[Peter Gulia]

Without questioning the logic of the ordering rule that JanetM describes, it illustrates another reason for stating the ordering rule in each plan’s documents.

As a plan’s creator or “settlor”, an employer may provide an employee-benefit plan on the provisions that it chooses (except a provision that’s void because it violates ERISA).

But when a plan doesn’t specify what to do and the plan’s administrator makes a rule, that might be a use of discretion. It’s okay to have discretion, but a plan's fiduciary must use its discretion “for the exclusive purpose of providing [the plan's] benefits to participants and their beneficiaries” and “with the care, skill, prudence, and diligence” of a prudent-expert fiduciary. That care and the statutory duty of ERISA § 406 preclude a plan fiduciary from using its discretion to benefit itself, or to benefit a person other than the participant.

It wouldn’t take much creativity for a person disappointed by smaller retirement savings (including the participant or his or her beneficiary or alternate payee) to argue that a plan administrator’s discretionary decision to favor a payment to itself over a payment to a participant’s retirement plan account is a self-dealing prohibited transaction. (The analysis might be different if the lender/employer had a legal right of setoff such that the loan repayment never became the participant’s wages.) And when a plan’s auditor asks for a “management representation” confirming the absence of a prohibited transaction, the plan’s administrator couldn’t responsibly furnish an unqualified representation.

Please don’t misunderstand: I don’t say that the ordering rule that JanetM describes is inappropriate. Rather, I suggest that an employer specify the plans’ ordering rule so that each plan’s administrator will restrict its act to applying the plan without resort to interpretation.

[Jean]

Isn't there an exposure to a plan stating ordering rules if they conflict with any State laws? I agree that the employer should approve the ordering rules, and have employee acknowledge them, but not that the plan should define them.

[GMK]

I'm missing something in all this.

From the original post, after deducting for payroll taxes, court ordered payments, and FSA, the remaining money can go to health insurance premiums and the 401(k).

While I agree that the employer would do well to have the employee agree what gets paid and what doesn't, I suspect that the 401(k) doesn't allow the employee to randomly change his/her deferral election for the 401(k) (except you can go to 0% deferral at any time).

If a deferral to the 401(k) ends up being less than the participant's current elected deferral amount, is there any problem that the plan administrator may not be operating in accordance with the plan document?

Should (can?) the plan say that the 401(k) deferral can be less than the election in the event that the money went first to other deductions that are at the participant's immediate discretion, including insurance premiums, United Way, etc?

Is there guidance that allows an employer to defer less than the elected amount to the 401(k)?

[Kimberly S]

The part I'm missing is why the participant wants to continue deferring if he is getting no paycheck because of it.

[GMK]

Kim, one possibility is that the participant's spouse gets lousy benefits. So, they maximize the participant's benefits, and use the spouse's income for food, rent, etc. Or they both maximize benefits, and the spouse's income is higher.