deferral % based on comp limit or total comp?

[WCC]

I hypothetically make $400,000 and I complete a deferral election form stating that I want to defer 4.375% of pay with the intent to max out at $17,500 for 2013. 2013 ends and I defer $17,500. The auditor says no, your deferral can only be $11,156.25 (4.375%*255,000).

Who is correct? I understand the match can only be calculated on the max comp limit, but does the salary deferral election only apply to the first $255,000 in comp?

Thank you

[ETA Consulting LLC]

It would depend on how the plan is written. The Regulations state that you may not use more than the 401(a)(17) limit (255K) for testing purposes. So, you can continue to defer after reaching that compensation limit, but you may not include more than that amount when testing the plan.

Good Luck!

[Flyboyjohn]

Stupid auditor, good example of a little knowledge being a dangerous thing, absolutely no connection between the two.

[Tom Poje]

See John
See John show auditor copy of preamble to 415 regs.
See John make auditor read this portion of the 415 regs page 13 of the pdf


“As noted above, the final regulations provide that a plan cannot take into account compensation in excess of the section 401(a)(17) limit. In addition, the final regulations provide that elective deferrals can only be made from compensation as defined in section 415©(3).
However, in applying these two rules, a plan is not required to determine a participant’s compensation on the basis of the earliest payments of compensation during a year.”

see John make auditor read last sentence 100 times, and stand in the corner

415 regs.pdf

[Tom Poje]

all kidding aside, I don't think there is anywhere in the code or the regs that 'specifically' states this concept, though it is considered common knowledge for most in the industry.

it is actually nice that there is something in writing, even if it is only in a preamble.

[rcline46]

Why not make the auditor back his/her position up with a cite? If we have to do so, so should anyone challenging our position!

[MWeddell]

If you have access to the ERISA Outline Book, they cite about four informal pieces of IRS guidance, such as newsletters, etc., where the IRS has consistently said that basing deferrals on total compensation doesn't bother them as long as the 402(g) limit / 401(a)(17) limit results in a deferral rate no greater than what NHCEs must do. A trickier issue is whether doing this complies with your plan document.

[BG5150]

I hypothetically make $400,000 and I complete a deferral election form stating that I want to defer 4.375% of pay with the intent to max out at $17,500 for 2013. 2013 ends and I defer $17,500. The auditor says no, your deferral can only be $11,156.25 (4.375%*255,000).

Who is correct? I understand the match can only be calculated on the max comp limit, but does the salary deferral election only apply to the first $255,000 in comp?

Thank you

The only way I see the auditors side is if you get only get paid once a year.

[Tom Poje]

therein lies the problem Mr Cline:

I could point to the regs and say, this clearly states "Limit comp to the comp limit". there is nothing that tells you "Oh, by the way, it is a snap shot at the end of the year"

as Weddell points out, it is 'informal' pieces of guidance we rely on. That is why I really appreciate the comment being in the preamble.

The caped Simpson makes a good point, but then he probably had to stay after school and write on the board 100 times....

[masteff]

therein lies the problem Mr Cline:

I could point to the regs and say, this clearly states "Limit comp to the comp limit". there is nothing that tells you "Oh, by the way, it is a snap shot at the end of the year"

as Weddell points out, it is 'informal' pieces of guidance we rely on. That is why I really appreciate the comment being in the preamble.

The caped Simpson makes a good point, but then he probably had to stay after school and write on the board 100 times....

AND... people such as the auditor in question look at the reg and presume that a salary reduction agreement for 4.375% is an annual self-imposed limit, rather than a per pay period payroll deduction. So they make faulty conclusions like, 4.375% * 255,000 = 11,156.25.

[K2retire]

This is easily solved by completing a deferral election with a dollar amount per pay period, rather than a percentage.

[Kevin C]

This little gem comes from a Q&A session in the mid 90's. The best I can recall, it was either 95, 96 or 97. It was a general 401(a)(17) limit question asking whether the $150,000 limit meant the first $150,000 of compensation. The IRS response was yes with no further discussion. Shortly thereafter there started being claims within our industry that deferrals were only allowed from the first $150,000 of compensation. Within a year or so, the IRS started informally stating that you were allowed to defer from all compensation, not just compensation below the 401(a)(17) limit. There was a Q&A question at the 1998 ASPPA annual conference that specifically says this. But, this nonsense refuses to go away.

[MWeddell]

This is easily solved by completing a deferral election with a dollar amount per pay period, rather than a percentage.

Joining you on this tangent ...

This strikes me as a really bad plan design idea.

(1) Given how infrequently participants tend to revisit contribution elections, this is likely to lead to a much less retirement savings because the contribution amount does not rise as the participant's compensation tends to increase over time.

(2) If a plan has a matching formula based on % of pay, one would want to enable participants to make their contributions as a % of pay.

[WCC]

Please help

I posted the OP a year ago and am now having the same issue again with a different auditor. I have provided the auditor with the 415 regs preamble as stated above byTom Poje. I have given an example from EOB and the auditor does not agree.

The question is:

I make $300,000 per year ($25,000 per month). I elect to defer 5% of pay (for the example $ amount elections are not allowed). I say the participant's deferral is $15,000 (300000*5%) The auditor says no, it can only be $13,000 (260000*5%). Regardless of when compensation is paid the total cannot exceed the % based on the annual limit.

I provided the 415 preamble again and the auditor says that is not why he disagrees. He is claiming that the 401a17 limit clearly states that when a % election is choosen, it can only apply to the annual compensation limit.

Is there any other documentation that can be provided?

Thank you

[david rigby]

As stated previously, you may need more than just the 415 reg, since the plan provisions are also important.

Attached are two separate Q&As from the Gray Book, 1999-30 and 2008-48, that reiterate the IRS position. (In case you are not familiar with the Gray Book, it is the result of informal discussions between actuaries and the IRS. It carries no official weight, but can be useful in identifying IRS viewpoint for situations and questions not directly - or not completely - addressed in regulatory guidance.)

GrayBook 1999.30 and 2008.48.pdf

[StevenM]

What if the employee terminates mid year and doesn't fully reach the 401(a)(17) limit? Wouldn't they have deferred a lesser percentage than they specifically elected because the Plan Sponsor or Payroll company assumed they would exceed the Annual Comp Limit?

[ESOP Guy]

WCC unless you just don't like changing net checks during the year why not solve this issue going forward by deferring say 7% or 8% of pay? (I didn't do the math but defer a % that allows you to get to at least the dollar max either way).

I think the auditor's are wrong but some times being right isn't as important as getting the right solution. I get that this results the withholding not being even through the year as you will hit the 4012(g) limit during the year but it seems simpler then fighting with auditors.

[401QUE]

Maybe this:

https://www.irs.gov/Retirement-Plans/401k-Plans-Deferrals-and-matching-when-compensation-exceeds-the-annual-limit

[rcline46]

Why is it that the pension community has to prove itself all the time. Why not make the 'experts' cite code and section for their incorrect positions?

[StevenM]

Maybe this:

https://www.irs.gov/Retirement-Plans/401k-Plans-Deferrals-and-matching-when-compensation-exceeds-the-annual-limit

We're familiar with that information and in the example Mary is deferring on a fixed dollar amount which is almost the exact amount she needs to defer each month in order to reach the maximum contribution limit for 2014,

The problem that I have is that an employee has requested to defer on a percentage of his compensation. However, the Plan Sponsor insists that he should not defer that specific percentage of his true compensation but that he should defer that percentage of the 401(a)(17) limit divided by the number of pay periods in the year because he's estimated to earn more than the 401(a)(17) limit. Does that make sense?

[Bird]

Does that make sense?

No. That is wrong, inaccurate, inappropriate, incorrect, a misinterpretation.

[My 2 cents]

Does that make sense?

No. That is wrong, inaccurate, inappropriate, incorrect, a misinterpretation.

Come on - what do you really think? Did you have a reason to leave out erroneous, fallacious, false and untrue?

Is it my imagination, or there about seven active discussion threads dealing with this one topic? It will be interesting to see if they all come to the same conclusion.

[rcline46]

We installed our first 401(k) in 1983, and probably been refuting this kind of argument since TRA 86. We also still run across CPAs who say that sole props and partners cannot defer at all because they do not have W-2 income. I have gotten old, tired, and grumpy (quiet Tom Poje!) about this because people cannot produce facts (code or regulations) to support their cause.

If you are hired because of your expertise and then the client wishes to over-rule you - well you know where you stand.....

[StevenM]

This is easily solved by completing a deferral election with a dollar amount per pay period, rather than a percentage.

In my situation the Plan doesn't allow Dollar Elections. Whole Percentage Elections only.

[ESOP Guy]

This is easily solved by completing a deferral election with a dollar amount per pay period, rather than a percentage.

In my situation the Plan doesn't allow Dollar Elections. Whole Percentage Elections only.

I would ask the powers to be to change that in the plan if they are going to also use their compensation interpretation. That would be a cheap and easy amendment and 401(k) plans should have that kind of flexibility any way.

[austin3515]

The auditor is ignorant. If someone makes 2,400,000 a year and elects to defer 1% of pay that is NOT a problem. It just isn't. It's that simple. The amount you are contributing is NOT based on compensation. Employee's are permitted to contribute $24,000 (if they are 50). How they get their is an administrative/operational issue.

Can I close this topic?

[StevenM]

The auditor is ignorant. If someone makes 2,400,000 a year and elects to defer 1% of pay that is NOT a problem. It just isn't. It's that simple. The amount you are contributing is NOT based on compensation. Employee's are permitted to contribute $24,000 (if they are 50). How they get their is an administrative/operational issue.

Can I close this topic?

Yes you can! As soon as you point to something official in writing that we can show the Auditor or Plan Sponsor or anyone else that disagrees with us. At the moment I have no choice but to abide by the Plan Sponsor's interpretation of how the Annual Comp Limit should be applied because I'm unable to prove that she's incorrect in her assumptions.

[austin3515]

I guess my point is it is semantics. 1% of pay = $24,000, or $2,000 a month. So if instead of electing 1% of pay, the participant instead made the exact same election, by requesting $2,000 a month the plan avoids disqualification?? How is it possible that on the one hand an election disqualifies the plan, while the exact same election worded differently does not?

How is that not proof in and of itself? 2 + 3 = 5, 3 + 2 = 5. $2,400,000 x 1% = $24,000 / 12 = $2,000 per month. These are all different ways of saying the SAME THING.

This is proof.

[K2retire]

This is proof.

But only for the logical!

The attorney who told me that it could not be done referred to the plan document's definition of compensation, which clearly says it is limited by 401(a)17. A deferral election based on a percentage of compensation, defined as the 401(a)17 limit would stop once that limit was reached according to him.

[austin3515]

Attorneys. Love 'em and hate 'em. Mostly love of course, but sometimes...

[Bill Presson]

Look at this Employee Plan News. I think this addresses the situation specifically.

https://www.irs.gov/pub/irs-tege/epn_2012_1.pdf

It's under the "We're Glad You Asked #2"

[austin3515]

Classic IRS. They knew what the big question was but avoided it by using a fixed dollar amount election.

[401king]

This still seems to be sufficient evidence, in that they are not excluding the paychecks after November from being 401k-deferral-eligible. It seems that the ill-informed would assume that any paychecks after someone hits $265k would be ineligible for 401k deductions, regardless of whether it were a percentage or fixed-dollar.

[Kevin C]

It's been mentioned a couple of times, but I did not see any responses addressing what the plan document says. Our VS documents (EGTRRA and PPA versions) have the following language in the definition of Compensation Limit that should remove all doubt:

In determining the amount of a Participant’s Salary Deferrals under the Profit Sharing/401(k) Plan, a Participant may defer with respect to Plan Compensation that exceeds the Compensation Limit, provided the total deferrals made by the Participant satisfy the Elective Deferral Dollar Limit and any other limitations under the Plan.

[ESOP Guy]

Look at this Employee Plan News. I think this addresses the situation specifically.

https://www.irs.gov/pub/irs-tege/epn_2012_1.pdf

It's under the "We're Glad You Asked #2"

Even though the example is on a fixed dollar amount the whole passage ends with this:

What does your plan say?

Although not common, a plan can specifically require that salary deferrals cease once a participant’s compensation reaches the annual limit. If your plan specifies that salary deferrals be based on a participant’s first $250,000 compensation, then you must stop allowing Mary to make salary deferrals when her year-to-date compensation reaches $250,000, even though she hasn’t reached the annual $17,000 limit on salary deferrals, and must base the employer match on her actual deferrals

To me that makes it clear that in their (IRS') mind your plan has to specify that deferrals be based on the participant's first $250,000 compensation to get the result the auditors are talking about.

I am with Austin at this point enough evidence has been given to support the belief of the people on this board. It might not be enough for the people who are asking the question but that says more about them then the evidence.

[My 2 cents]

One presumes that if the plan DOES say that deferrals are limited to the first $250,000 of compensation, the sponsor would be at liberty, without fear of disqualification, to amend it out effective immediately. Why would one want to have such a provision?

It's January 4th, and (presumably) the issue has not come up yet this year. Check your plans and, if you find that language, consider amending it out before anyone is restricted from making the salary reduction they want by a technicality.

[Bird]

As noted way back by someone else, the burden of proof should be on the one making the (erroneous) claim that deferrals can't be made on comp over the limit. (Assuming the document itself does not have such a limit, which is unlikely at best but easily checked.)

The question here is not one of law or regulations - the question is, who is in charge and who is being paid to do what? The original poster needs to nut up and say "you're wrong because I know more about this than you do and I say you're wrong." And if they (I'm not paying that much attention...auditor or plan sponsor or whomever "they" is) still insist, then put it in writing and note that they are violating the participant's rights to make contributions and potentially causing plan disqualification by creating some arbitrary limitation not existing in the plan document.

Enough already.