Back-pay--to defer or not

Company has to give people "retro pay" going back to 2022.  Do they need to take deferrals from those?  Do they need to include that income for the 2022 and/or 2023 ER contributions?

It's a 403(b) Plan, and the document excludes all post-severance compensation.

But it this post severance pay?  It should have been paid way back when.  It's not like a trailing commission or a bonus that was genuinely paid post-severance.

Your thoughts are apprciated.

This might be back pay within the meaning of 1.415(c)-2(g)(8). If so, it's considered compensation for the year to which the back pay relates, so 2022 or 2023 in your case.

Quote

(8) Back pay. Payments awarded by an administrative agency or court or pursuant to a bona fide agreement by an employer to compensate an employee for lost wages are compensation within the meaning of section 415(c)(3) for the limitation year to which the back pay relates, but only to the extent such payments represent wages and compensation that would otherwise be included in compensation under this section.

Does the document address back pay at all?

This is definitely an area where we could use some additional guidance.  It comes up reasonably often, and the existing guidance is frustrating.  On the one hand, the regulation C.B. Zeller cites above very clearly addresses the handling for 415 purposes and provides that the back pay is generally taken into account with respect to the year to which it relates.  However, make sure to also look at the plan document's definition of plan compensation for allocation purposes.  For example, many plans use W-2 comp.  These back-pay amounts won't be picked up on the employees' W-2 until the year of payment.  Depending upon the exact facts presented, this mismatch can lead to bizarre outcomes and can sometimes mean that the individual is not permitted any deferrals or employer contributions on the back-pay.  (It gets extra fun when the back-pay award explicitly states that the employee is entitled to them.)

Determining the year in which back pay will be considered for purposes of a retirement plan can be mind-breaking for several reasons:

• Back pay affects hours of service for the year to which the back pay was made which likely is a factor in determining
  • eligibility service.
  • vesting service.
  • allocation conditions.
  • breaks in service.
• Back pay affects compensation, and compensation likely is a factor in determining the
  • amount of benefit accrued in any year.
  • whether the employee was an NHCE or HCE.
  • whether the employee was a key employee.
  • plan limits including 415 or caps on compensation eligible for deferrals.
  • ADP/ACP testing.
  • Social Security Taxable Wage Base (think integrated formulas).
• Back pay awards may include items that are not related to an employee-employer relationship.

As a general principle for making any plan correction, the affected participant or participants and any other participants in the plan should not be harmed by the correction.

This principle on its own should be sufficient to say a correction is okay if the benefit an individual is made whole if they get a current year correction to provide the benefit the individual would have accrued after applying back pay to each year for which the back pay is related (plus earnings).

With some recognition that availability of data, effort needed to apply a correction, and common sense are relevant, then demonstrating that an individual will be made whole or better if the back pay is applied in the current year also should be consistent with the general principle.  In this case, it would be important to demonstrate that the plan would not have any deficiencies (test failures, coverage issues, violations of limits...) if the back pay was not included in the plan accounting.

Obviously, this is not the granular type of analysis supported by a multitude of common and obscure regulatory references.  This approach is akin to an argument to be made if the plan is under review.  Rather, this is from the Hippocratic school of retirement plans: "Practice two things in your dealings with retirement plans: either help or do not harm the participants."