Can employee 401(k) contributions be made from severance pay?

[Guest Sonia Kapoor]

My query is:

Are the severance pay package offered by an employer eligible compensation from which employee 401(k) contributions can be made?

[Kirk Maldonado]

What does the Section 401(k) plan say?

[Guest Sonia Kapoor]

The 401(k) Plan does not specify any provisions for such a scenario. Hence, the query.

[Guest kstorch]

I'm also curious about this question. If an employee has terminated but receives a severance package can they defer any of that to the k plan. My thought was that maybe you could consider part of the severance a "bonus" and if the document allowed, you could defer a piece of your bonus into the plan.

[pjkoehler]

Sonia,

You're going to have to analyze the plan document to determine if the definition of "compensation" for CODA purposes includes the severance pay to which you refer. If it doesn't, case closed. If you determine that the definition includes such severance pay and there is a valid pre-existing CODA election with respect to such pay, then you have an issue that has yet to be resolved (to which KJohnson refers as the subject of a battle royale in a prior thread). You first have to distinguish between the form of severance pay in terms of whether it was paid for the performance of past services to the employer (arguably "compensation" to which 401(k) may apply) or for the loss of a job (a mere welfare benefit to which 401(k) does not apply). Generally, the closer in time to the employee's date of termination, the better factual basis you have for arguing that the severance pay was compensation for performance of past services. If you conclude that it was compensation for the performance of services, you then get to the grand issue: Whether an employee's cash or deferred election controls the pre-tax treatment of amounts of compensation paid after the date of termination? The contributors to the prior thread have been waiting for a plan sponsor that would be so inclined to obtain a legal opinion or seek a PLR on this issue. Think your company would be interested?

[IRC401]

Has anyone had to deal with the issue of a former employee who is awarded back pay by the NLRB and who wants to make 401(k) contributions on the back pay. (Assume that had the back pay been paid when it should have been paid, it would have been subject to a 401(k) election in effect at the time.)

[davef]

IRC401,

I recently encountered the same issue, and advised the employer to allow the person to defer a portion of the backpay award on the grounds that, had it been paid originally, the employee could have deferred at that time. I don't know if that is the correct approach, but it seems to make some sense. (I could also argue that the deferral should not be allowed, since the person is no longer an active employee.) In this case, we limited the person to $10,500, although perhaps one could take an agressive position and allow the person to defer more if the backpay award spanned multiple years. You also run into ADP testing issues -- do you re-run prior years tests or count the deferral in the current year? Also, there may be payroll issues on how the backpay award is paid to the person, net of the deferral. Finally, the employer needs to know that this is not a black and white issue and that there could be risks attached to this approach.

[Guest Sonia Kapoor]

Thank You All for your views. Although this is still a pretty grey area, your comments have started a thought process.