Deferral Compensation

[DTH]

An employer has a 401(a) plan with a pick-up of 4% of compensation and also has a 457(b) plan. An employee makes $50,000, so $2,000 will be picked up and contributed to the 401(a) plan. The employee is deferring 10% of compensation. Do you take 10% of $50,000 or $48,000? Is this dependent on the 457(b) plan's definition of compensation? I think no matter what the plan's definition of contribution compensation is it would be $48,000 because pick-up contributions are considered employer contributions.

Can you please confirm this. Thank you.

[Carol V. Calhoun]

The plan can define compensation any way it wants, for purposes of defining what a participant's election means. And in my experience, they typically define it to include the picked-up amounts as compensation, because most employees think of pick-ups as being mandatory employee contributions (even though for federal tax purposes, they are treated as employer contributions).

Let's look at it this way: The person who makes $50,000, and whose pick-up is $2,000, could clearly contribute $5,000. If for some reason the IRS were to take the position that the plan's definition of compensation had to be $48,000, the person could simply defer 10.42% of compensation instead of 10%. Why would the IRS care whether the plan said that the person was treated as deferring 10% or 10.42% of compensation?

Clearly, the maximum limit is no more than 100% of includible compensation, and includible compensation does not include pick-ups. But the 100% of includible compensation maximum limit is seldom relevant anyway. (It would apply only to someone whose compensation was less than $18,000, and few people with that level of compensation want to put the maximum into a 457 plan.) So what plans often do is to have a definition of compensation for purpose of determining deferrals that includes pick-ups, and a separate definition of includible compensation for purposes of determining the maximum which excludes pick-ups.