Different definition of compensation for deferral and match contribution

[ErisaGooroo]

I'd like to get the group's opinion on how the Actual Deferral Rate is calculated in a 401(k) Plan has a discretionary matching formula of 50% up to 10%, when different exclusions apply for match than for deferrals, defined below.  

We have a differing of opinions on how the match should be calculated.  Method #1 calculates the ADR based on deferrals and plan comp for deferrals.  Method #2 calculates the ADR on deferrals and plan comp for match.  Method #2 produces a higher % which increases the match amount but doesn't exceed the maximum match available based on 5% of match comp.  

Method #1:  

• Plan compensation for deferral:  W-2 excluding fringe etc ($124,124.00)
• Plan compensation for match:  W-2 excluding fringe etc, bonus, overtime, commission. ($82,726.58)
• Employee Deferral: $9.800.  ADR 7.9% ($9,800.00/$124,124.00)
• Total match:  $3,265.76.  ACR 3.95% ($3,265.76/82,726.58)
• Maximum match available:  $4,136.33 ($82,726.58 * 5%).

Method #2: 

• Plan compensation for deferral:  W-2 excluding fringe etc ($124,124.00)
• Plan compensation for match:  W-2 excluding fringe etc, bonus, overtime, commission. ($82,726.58)
• Employee Deferral: $9.800.  ADR 11.85% ($9,800.00/$82,726.58)
• Total match:  $4,136.33.  ACR 5.0% ($3,265.76/82,726.58)
• Maximum match available:  $4,136.33 ($82,726.58 * 5%).

Questions:  

• Which method is correct?  Method #1 - bases the ADR on deferrals/deferral plan comp where Method #2 bases the ADR on deferrals/match plan comp.  
• Is there any flexibility in how the ADR is calculated for allocation purposes when the plan document defines match comp differently?  

I understand the testing implications (ACP, 414(s), BRF) are separate issues here.

Thank you in advance for your feedback.  

[Bri]

I believe your Plan Administrator gets the final call on the interpretation of plan terms.  Especially if it's not totally spelled out in the document.  Maybe check references in the allocations section of the BPD how they as document authors expect the match to be determined.

(My guess-off-my-head is that you'd use match comp for calculating match contributions even if it's a higher ADR to the participant, so your method 2.)

[Paul I]

Be very careful in reading the plan document, particularly where there is an Adoption Agreement and a Basic Plan Document.  Typically, the capitalized terms in the Adoption Agreement is a clue that there is a formal definition elsewhere in the AA or BPD that provides a more detailed description of what is or isn't considered where the term is used.

Where the plan documentation allows for alternative definitions of a term like "Plan Compensation", it effectively is creating multiple, separate terms like "Plan Compensation for Deferrals", "Plan Compensation for Match", "Plan Compensation for NEC".

After wading though the plan terms in fine detail, the step through the calculations.  In the OP, it may be the case that 50% match rate is applied to the actual dollar amount of the deferrals, but the 10% maximum may be based on the deferral rate or may be based on the Plan Compensation for Match.

If ultimately the plan is silent or ambiguous, then the Plan Administrator will need to provide guidance and document that guidance for posterity. 

[Peter Gulia]

And if the documents governing the plan refer to the Internal Revenue Code or Treasury rules interpreting or implementing the Internal Revenue Code, consider those sources too.

Does your nondiscrimination-testing software provide any ordering or guidance about your question?

[CuseFan]

As all said - dig into document details carefully.

Without knowing how those plan provisions are laid out, my opinion given how you describe them is the person should get a match equal to the lesser of 50% of their deferrals ($4,900) or 5% (50% x 10%) of match plan compensation ($4,136.33). I don't see any logical way for method 1 to apply.

 

[ErisaGooroo]

Thanks to all who responded. Your input is greatly appreciated.  

After further analysis, I landed on Method #1. The example below vary slightly from the OP because it is based on an actual participant $$$.

For illustration:

• Employee deferral compensation: $124,1124.42
• Employee matching compensation: $82,726.58
• Elective deferral percentage: 7.90% of deferral compensation ($9,800 / $124,124.42)
• Total deferral: $9,800
• Deferral corresponding to matching compensation: $82,726.58 * 7.90% = $6,535.40.

 Under the plan’s match formula, (50% of deferrals up to 10% of matching compensation), the employer match is calculated on the deferral attributable to the matching compensation.

 Step #1: Determine matchable deferrals

• Matchable deferrals cap: $8,272.66 ($10% * $82,726.58)
• Actual eligible deferrals ($6,535.40) are below the cap.

 Step #2: Apply the 50% match

• 50% * $6,535.40 = $3,267.70

 Step #3: Confirm against maximum possible match

• Maximum possible match:  5% * $82,726.58 = $4,136.33

 Since $3,267.70 is less than $4,136.33, the calculation is valid and does not exceed the plan’s maximum.

 Conclusion

• Maximum possible match: $4,136.33
• Actual match earned: $3,267.70
• Reason: Employee deferred 7.90% of matching compensation, which is below the 10% deferred cap required to receive the full match.

 

Why Method #2 doesn't work:

Under the Plan, the match is not calculated based on the derived or applied deferral rate that results from dividing total employee deferrals by matching eligible compensation. Doing so would replace the plans explicit formula with an alternative methodology that is not described in the plan document. Instead, the match must be calculated strictly in accordance with the plan’s stated matching formula and compensation definitions. The plans match is formula driven, not right driven. The plan’s matching contribution is defined as 50% of employee deferrals up to 10% of matching compensation.

 This formula requires 2 separate steps:

•  Identify the dollar amount of the employee deferrals attributable to matching eligible compensation.
• Then apply the 50% match subject to 10% of matching compensation cap.

Total employee deferrals are calculated using a broader compensation definition than the one used for the match. As a result, total deferrals may include contributions made on compensation that is not eligible for matching (such as bonus or overtime). When total deferrals are divided by matching eligible compensation, deferrals attributable to non-matching compensation are improperly included in the calculation. This artificially inflates the implied deferral percentage. The resulting rate does not reflect the participants’ actual deferral rate based on matching eligible pay. This approach conflicts with the plan's design which limits match strictly to deferrals made on matching eligible compensation.

 

Final takeaway

• The match is calculated using the matching compensation definition not the deferral definition.
• The employee does not automatically receive a match equal to 50% of 7.90% of total W-2 comp.
• You must isolate deferrals attributable to match compensation first then apply 50% of the 10% formula.