401(a)(17) limits on HCE who resigns mid-year

[SandyAZ]

Our plan is highest 36 months salary for benefits calculation.  I'm trying to understand how 401(a)(17)-1(b)(3)(iii) - sections (A) and (B) work in regards to an employee who resigns mid-year.  Sub-paragraph (A) appears to state that the HCE's earnings are capped on a prorated basis ($345,000/12 per month), while sub-paragraph (B) appears to state that the proration does not apply to a partial year employee. 

If an employee has salary above the 401(a)(17) limit, e.g. they have an annual salary of $600,000, which is above the 2024 limit of $345,000, and they depart on 6/30, how do (3)(iii)(A) and (B) apply? 

Paragraph (A) states "Proration required. If compensation for a period of less than 12 months is used for a plan year, then the otherwise applicable annual compensation limit is reduced in the same proportion as the reduction in the 12-month period." - so the $600,000 would be capped by a pro-rata amount of the annual limit, or $172,500, even thought their six-month earnings of $300,000 was below the annual cap of $345,000."

And: "if the period for determining compensation used in calculating an employee's allocation or accrual for a plan year is a short plan year (i.e., shorter than 12 months), the annual compensation limit is an amount equal to the otherwise applicable annual compensation limit multiplied by a fraction, the numerator of which is the number of months in the short plan year, and the denominator of which is 12"

While (B) has three separate statements, the second sentence appears most applicable to this situation:

"No proration required for participation for less than a full plan year. Notwithstanding paragraph (b)(3)(iii)(A) of this section, a plan is not treated as using compensation for less than 12 months for a plan year merely because the plan formula provides that the allocation or accrual for each employee is based on compensation for the portion of the plan year during which the employee is a participant in the plan.

In addition, no proration is required merely because an employee is covered under a plan for less than a full plan year, provided that allocations or benefit accruals are otherwise determined using compensation for a period of at least 12 months.

Finally, notwithstanding paragraph (b)(3)(iii)(A) of this section, no proration is required merely because the amount of elective contributions (within the meaning of § 1.401(k)-6, matching contributions (within the meaning of § 1.401(m)-5, or employee contributions (within the meaning of § 1.401(m)-5 that is contributed for each pay period during a plan year is determined separately using compensation for that pay period."

I'm confused how these work together and which actually applies to an HCE as in my example.

[CuseFan]

You must prorate if you have a short plan year, but not for any individual's participation that is less than 12 months, that is not a short plan year. If someone enters plan 7/1/2024 and makes $345,000 from 7/1-12/31/2024, it all counts. If an existing participant terminates 6/30/2024 and made $345,000 from 1/1-6/30/2024, it all counts.

[SandyAZ]

Thank you for the reply, is that because sub-paragraph (B) is the applicable paragraph? 

Also, can a plan override this and adopt a "Pro Rata" methodology?

Edit - Upon further reading of 401(a)(17)-1(b)(3)(iii) - subparagraphs(A) and (B), it appears to me that (B) applies to most plans and that (A) only applies if a plan has "compensation for a period of less than 12 months is used for a plan year", which is not typical.  

It would be helpful if I could get more details on how "If compensation for a period of less than 12 months is used for a plan year" is defined, since (B) states, "a plan is not treated as using compensation for less than 12 months for a plan year merely because the plan formula provides that the allocation or accrual for each employee is based on compensation for the portion of the plan year during which the employee is a participant in the plan".  These two conditions are subtle and I'm having trouble understanding specifically what would fall into (A).

 

[Calavera]

23 hours ago, SandyAZ said:

Our plan is highest 36 months salary for benefits calculation. 

I believe if your plan's benefit formula using 36 months and not 3 years, you have to apply a monthly limit to a month of compensation, essentially applying the proration. 

[SandyAZ]

10 minutes ago, Calavera said:

I believe if your plan's benefit formula using 36 months and not 3 years, you have to apply a monthly limit to a month of compensation, essentially applying the proration. 

Thanks for the reply.  That's part of my confusion, as subparagraph (B) [not prorated] states "a plan is not treated as using compensation for less than 12 months for a plan year merely because the plan formula provides that the allocation or accrual for each employee is based on compensation for the portion of the plan year during which the employee is a participant in the plan" while (A) [prorated] states "If compensation for a period of less than 12 months is used for a plan year".  So it seems to pivot on exactly how the plan year is defined (by a number of months, for example)?   I'm not clear on the exact distinction between "is used for a plan year" vs "the plan formula".

[Calavera]

First you take into consideration whether you have a short plan year or a 12 month plan year. Then you look at the benefit formula and employment/participation history.

See CuseFan's comments above.

If you have a short plan year or if you have a benefit formula that using monthly compensations, you prorate.

If you have a full plan year, and you have a benefit formula that is not using monthly compensation, you don't prorate.

 

[david rigby]

On 10/23/2024 at 2:50 PM, SandyAZ said:

Our plan is highest 36 months salary for benefits calculation. 

In over 40 years of plan review, I've never seen any plan sponsor that tracked payroll data by month.  If this sponsor cannot do so (easily!) then I suggest you give strong consideration to using annual comp.