401k employee contributions

[Guest CSJB]

Please provide your thoughts about an unusal pay practice that I have encountered on a new position. As a benefit professional, I am very concern that this practice is not compliant with 401k regs. There are two groups of employees who reside in the same classification under the plan. Both groups are in the same incentive plan. The company pays One group's employee's incentive in the form of cash and 401k employee deductions are applied as any other compensation. The company pays the other group's incentive in the form of a gift card where the employee recieves gross up for applicable taxes AND the company 'grosses-up' for the employee's 401k contribution plus adds the normal employer contribution. Since both groups of employees are in the same incentive plan, the same classification for the 401k plan, I believe this is preferencial treatment and also is not considered qualified compensation (for the gross up of employee contributions). The internal legal review believes this is in compliance. Can you provide any guideance whether this practice is compliant or not. If not, can you provide specific case law or reg to help guide me to the light? Thank you.

[QDROphile]

Sounds like the employer has simply chosen to pay different incentive compensation amounts to different persons, all recognized as W-2 pay. As long as the payments and deferrals are executed properly and the plan document describes the compensation properly, there is no discrimination with respect to benefits. Benefits are based on W-2 pay amounts. The differences with respect to W-2 pay are not an issue for plan. Such differences occur under almost all 401(k) plans that have more than one participant.

[masteff]

I think we have to split this into two separate pieces. First we have the seemingly different treatment of the two groups of employees. Second we have the gross up of the gift cards for employee contributions.

As to the different treatment. I don't see a problem w/ this in the plan. It's a pay practice outside of the plan and is not providing one group w/ greater benefits under the plan itself. Both groups are allowed to defer on the incentive income and, presumably, receive the same structure of company match, etc.

As to grossing up the gift cards. My concern is thus.... How would three different employees be treated if their deferral elections were as follows: 0%, 3% and 15%? Or to put it another way, how much gross up is given to each employee? The problem is that 401(k) deferrals have to be a cash or deferral election. I can't tell you that I'll give you $10 but only if you defer it. You have to have the choice to take that $10 as cash (or other taxable benefit, such as adding the $10 to the gift card). So if our three hypothetical employees were each given a $100 gift card and then given $0, $3 and $15 dollar grossups for their deferrals, then the company might be violating the "cash or deferral" requirement of the code and regs. Note that I use the words "might be" because I'm not an attorney and there may be finer nuiances to the law that I'm not fully versed on. See reg section 1.401(k)-1(a)(3) (especially subparagraph iii which says "a cash or deferred election can only be made with respect to amounts that would (but for the cash or deferred election) become currently available"; the $3 and $15 in my example would not have been available in the absence of the election, violating this part of the requirements.)

Edit: revised last sentence, was a in a rush last night when I wrote it and emphasized the wrong final point.