401k Matching True-Up Question

Have client with a matching formula that states: 

On a payroll basis, you get 6% match if you contribute 2% or more.  If you contribute less than 2%, no match. (Long history behind how this formula came about.)   Obviously most participants contribute 2% or more.  Recently the plan was amended to also require that a true-up be made at year end based on annualized wages / deferrals.  This was generally to help those who front-loaded their salary deferral contributions. 

However, based on this formula, what do you do in the case of a participant, who has been eligible for years but not contributing, suddenly starts contributing mid-year at 2% - getting the 6% match each payroll period.  When you annualize the formula, this participant's deferral percentage will be less than 2%.  This means he is NOT eligible for any match for the year per the formula.  I don't think this was the intent when they elected the true-up option.  If the formula was dollar for dollar up to 6%, I don't think it would present a problem.

I think the client will want to do whatever is the easiest to administer which I believe would be to eliminate the true-up option (and tell participants to not front-load their contributions) - assuming they stick to the formula as is.  Taking money out of the participants account is rarely the desired outcome if preventable. 

Question:  Can you apply the "true-up" feature only in situations where you are adding funds, not taking away funds (regardless of HCE / NHCE status)?   Although that initially strikes me as problematic  - not operating in accordance with the terms of your plan.  I do think that most participants who would fall into this situation would more than likely be NHCEs.  I think we in the industry generally view the true-up feature as a situation where the employer is always ADDING additional contributions to a participant's account by the employer. 

Just briefly reading over your post, why don't you have the employer fund the contribution after the plan year? Just do one big contribution? 

Don’t you have to test this match formula for effective availability when you have a match that increases as the deferral amount goes up?

I see three frames for thinking about these questions:

For a year that ended:

The plan’s administrator must read the documents governing the plan. If this leads to one clear finding about whether the plan provides not only a true-up but also a true-down, so be it.

If the documents are ambiguous, the administrator must—with “the care, skill, prudence, and diligence” ERISA § 404(a)(1)(B) requires—interpret the documents to discern the plan’s provision.

If on text interpretation alone, none of the plausible interpretations is readily better than others, the administrator might interpret the documents considering the “exclusive purpose of . . . providing benefits to participants and their beneficiaries[.]” ERISA § 404(a)(1)(A)(i), 29 U.S.C. § 1104(a)(1)(A)(i).

And if there is written evidence that the plan’s sponsor intended that the plan would tax-qualify under Internal Revenue Code § 401(a), the administrator might favor an interpretation that supports tax-qualified treatment over an interpretation that risks not meeting all tax-qualification conditions. (Listen to Bill Presson’s question.)

For a year that has begun:

If the plan’s sponsor considers amending the documents, it would consider whether a midyear amendment could contravene ERISA § 203 [29 U.S.C. § 1053].

In doing so, one might consider that Treasury rules interpreting Internal Revenue Code § 411 also are, to the extent Reorganization Plan No. 4 of 1978 provides, interpretations of ERISA § 203, except for § 203(a)(3)(B).

Before a year has begun:

The plan’s sponsor might consider amending the documents to apply its desired provision to years not yet begun.

Might the sponsor prefer providing a true-up, but no true-down?

None of this is advice to anyone.

I'd be worried that a true-down is actually a cutback if the calculation and allocation are paired together at the pay period (rather than annual) level.

The true-up is a contribution that results in the participant receiving the match promised under the plan using the match formula.

If the participant has been given more match than due using the match formula, that is an excess amount and should be removed from the participant's account.

There is no need to create a new term ("true down") to describe the situation.

Bruce, yes, that would be an easy fix going forward but not really the client's desire, nor the participants.

Bill - yes - you are right on that point with the effective availability.  Fortunately this impacts only a few participants (small %) each year.

I struggle between Paul I's point and Peter's points - for which I think a case can be made to either side of the equation.   Looking at future years, I like the idea of true up only.  I really hate having to remove funds from a participant's account over what I would refer to as "unintended collateral damage" to the sponsor's attempt to positively impact participants.  It present a PR problem for sure.

Bri - possible - but I think the true-up feature would override the "payroll calculation" since that is, in essence, the point of adding the "true-up" provision to the Plan.

I'd prefer the client to change the formula to eliminate the issue altogether and have the best of all worlds.  Especially since it impacts a small # of participants each year.  Most participants are intending to contribute at least 2% to get the full match - why would you not.

Thanks for all your input.  At least I was thinking along similar lines as to the issues this situation raises.  I'll report back as to what comes of it ...