Unused Vacation Pay - Can it be derferred?

[katie58]

I have a client that has a number of employees with unused vacation. They questioned whether or not this unused vacation could be deferred into the 401(k) Plan. They want to get this obligation off their books and thought perhaps they could avoid payroll taxes with this option.

Their plan does not currently permit this type of contribution.

Has anyone had experience with this?

Would it be considered an employee contribution and require employer match? Or would it be a QNEC?

Any insight would be appreciated!

Thanks

[My 2 cents]

Should it be possible to pay unused vacation time out without having to deal with payroll taxes? That doesn't seem right.

You would start with deciding to allow people to cash out some or all of the unused vacation time, and then allow deferrals into the 401(k) plan of some of the amounts otherwise available as cash. Would there be any other mechanism for this?

It is my understanding that it is entirely legal to limit the amount of unused vacation time that can be carried forward, even to have anything over that limit be forfeited (rather than cashed out). Employees should be given adequate advance notice of the change in policy, to permit them to work in enough vacation days taken to not lose anything outright.

[ESOP Guy]

There is a 2009 rev ruling on this topic

http://www.irs.gov/pub/irs-drop/rr-09-31.pdf

[MWeddell]

There have been plenty of articles over the years regarding making contributions to 401(k) plans from unused vacation pay. There are two methods:

1. Employees choose whether to make the contributions or to receive them in cash. This is just another cash or deferred election, so the dollars are subject to 402(g) limits and ADP testing. Obviously look at the plan compensation definition in your plan document.
2. Employers make a nonelective nonmatching contribution of unused vacation pay. Subject to 401(a)(4) general testing if any HCEs receive these dollars and one should question how likely it is to pass that test.