Deferral procedures

[Belgarath]

Here's a new one to me. Plan deferral procedures and deferral forms specify that

all deferrals, whether by percentage or by flat amount, will be deducted twice monthly (24 pay periods per year) even though they actually do bi-weekly payroll (26 per year.)

Match is on a "per payroll" basis. Not a safe harbor plan, not top heavy.

Although odd (in my experience) is there really a problem with this? Plan is allowed to establish deferral procedures, so do you foresee problems for an auditor with this practice? Assume no HC, so no possible testing failures involved. Seems to me that this should be ok, even though it feels a little funny in that plan definition of compensation doesn't specifically refer to this. But for a flat dollar deferral amount, the number of payrolls is ultimately immaterial, and for a percentage, as long as forms clearly specify that it is for 24 payrolls only, participants know exactly what they are signing up for.

Any thoughts?

[QDROphile]

Do the participants know which 24 pay periods will have a reduction? Is the election annual?

[Bill Presson]

I haven't seen it on 401(k) plans, but I've seen employers do it on health insurance. Since they have monthly premiums, they want the 24 pay periods so it matches up. The two pay periods they skip are for the two months that have three pay dates each year.

I would be uncomfortable to do it if someone has chosen a percentage though. Just thinking out loud.

[hr for me]

We do this type of deduction for Health insurance premiums, so our employees get the last 2-3 payroll cycles (end of calendar year) "free". But I have never heard of such a thing for 401k deferrals. You might have some issues with your plan compensation definition since you would be using 100% of a whole year's compensation. And if you have employees who make varying wages throughout the year, their ADP might not be as close to their election on an annual basis as they might want it to be -- depending on which 2 payrolls don't have deferrals.

I have to wonder if at some point the payroll cycles changed and the 401k wasn't updated to match.

And I suspect you will have a lot of communication issues and misunderstandings. Enough that it would be worth it to fix it now rather than later.

One last thing that we know from processing biweekly --- every 7-10 years, you will actually have a year with 27 payrolls....fun stuff!

[Belgarath]

Thanks.

Match is discretionary, and is on a "per payroll" basis, so for any payroll (the 3rd payroll in each of the 2 months that have three payrolls) there would be no deferral and no match.

We would recommend that this be modified for 2016, by the way, or at least referred to counsel...

And, I just found out this is a 403(b) and not a 401(k), so ADP and Top Heavy wouldn't be an issue even if they had HC/Key, but they don't anyway.

The document is pretty open-ended on deferral procedures - allows a lot of employer latitude, so I'm thinking that as long as the participants are appropriately notified. One of the clauses that seems to allow some wiggle room is:

© Additional Rules. The Plan in the Plan's Salary Reduction Agreement form, or in a Salary Reduction Agreement policy will specify additional rules and restrictions applicable to a Participant's Salary Reduction Agreement. Any such rules and restrictions must be consistent with the Plan and with Applicable Law.

Also, compensation refers to...

(2) to all Elective Deferral Compensation or Salary Reduction Agreement Compensation as the Employer elects in its Adoption Agreement, unless the Participant in his/her Salary Reduction Agreement elects to apply the Agreement only to a lesser amount of such Compensation.


Anyway, I don't know what an auditor would think, but the question becomes whether some sort of self-correction is required, or if the Plan is ok on this issue.
And one could argue that "correcting" the plan - that is, requiring an additional deferral on the two extra paychecks - would itself be a violation if the clear intent of the deferral forms (with latitude permitted by the plan, and forms signed by the participants) is to limit the deferrals only to the 24 payrolls.

There's way too much gray here for my taste!

[Belgarath]

P.S. - here's the note that appears on the salary deferral form. Fairly specific. They also have all benefit deductions for cafeteria plan, etc., done on one form, hence the reference to Flexible Benefits, which has nothing to do with the 403(b) deferral...

**NOTE** All Flexible Benefits will be paid out based on 26 pay periods, however elected benefit deductions will be paid out based on 24 pay periods, resulting in 2 paychecks each year with zero deductions. This will take place when there are 3 pay periods in a month, which you will see in May & October for 2015.

[QDROphile]

Paid out? How much more confusion could be created? The arrangement and disclosure appear to be a disaster. It is bad enough with the health plan elections, which are annual elections. Are the 401(k) elections annual? I do not see how this can make any sense to the poor particpants if the election rate can be changed during the year.

[hr for me]

Have to agree with QDROphile that communication is confusing. I would have a separate 401k election form since the deferral percent is not an annual election, but can be changed throughout the year, right? I've not seen any 401k where it is an annual election, even back in the olden days when we processed quarterly on the mainframes!

[Kevin C]

Also, since this is a 403(b), you might have issues with universal availability if losing the ability to defer from those two pay periods means that someone doesn't have the effective opportunity to defer the max. See 1.403(b)-5(b)(2).

[Belgarath]

Thanks for all the comments. Believe me, none of this is my idea. I also have never seen such an election. But someone has done it, so now I'm just looking for ways the reasonably argue that what they already did was allowable. They may well still "make up" the May payroll...

Confusing? You have no idea! It is much worse than you think - I'm only discussing 1 piece of this oddity, and not by any means giving you all the issues/details. I keep thinking it is a bad dream from which I will awake, carefree and happy.

Kevin - your point is well taken, but in this case I actually have no worries about that. Since they had to sign a new election for 2015, are informed up front that it is based on 24 pay periods, and can change during the year, I think the facts and circumstances would pretty clearly support that they have an effective opportunity to defer the max. But maybe my normal conservatism is on vacation today.

[Kevin C]

My point was that if someone has compensation for the full year sufficient to defer the $18,000/$24,000, but doesn't have sufficient comp for the 24 pay periods to do so, you violate the following sentence in the cite:

Further, an effective opportunity includes the right to have section 403(b) elective deferrals made on his or her behalf up to the lesser of the applicable limits in §1.403(b)-4© (including any permissible catch-up elective deferrals under §1.403(b)-4©(2) and (3)) or the applicable limits under the contract with the largest limitation, and applies to part-time employees as well as full-time employees.

I don't see anything that gets you around this by telling them up front about the restriction.

[Belgarath]

Hmm - good point! So, do you interpret this such that if there is someone who only makes, say, $10,000, and can't defer the entire $10,000, that you have a violation?

[Kevin C]

Yes, although being nit-picky, after FICA, the max deferral would be $9,235.

[Belgarath]

Gracias.