Short Plan Year and Proration

We have a brand new start up plan.  The effective date of the plan is 9/30/2020.  Calendar year plan.  Document indicates a short plan year.  Compensation is defined as plan year.  So, I believe I need to prorate the compensation.  The question is do I use 3 months or 4 months?  Or should I be using days?

For the 415 limit for contributions, there is language in the document that states:  The Limitation Year for Code 415 purposes will be the 12 month period ending on the last day of the Plan Year instead of the "determination period" for compensation.    Based on this language, do I need to prorate the 415 for contributions?

Three main items apply here:

1. As you mentioned, only compensation earned after the effective date of the plan may be used to determine contributions

2. The 415 dollar limit must be prorated based on months the plan is in effect. In this case the 415 limit would be $57,000 x (3/12) = $14,250

3. The 401(a)(17) annual compensation limit must be prorated. The calculation is the same as the 415 calculation: $285,000 x (3/12) = $71,250

As a side note the 402(g) limit is not affected as it is an individual limit based on a calendar year. So assuming a participant has not made any elective deferrals to any other plan (even plans maintained by other employers) the participant can still contribute $19,500 in the last three months assuming that they earn enough during that period to defer the maximum.

Many times an employer will want to start a plan later in the year but may not want proration to gum up the works. The solution is to make the plan effective on the first day of the calendar year during which it is adopted (1/1/2020 in your case). While participants can still only defer on compensation earned after the plan is adopted a discretionary profit sharing contribution could be made an allocated on full year compensation. 415 and 401(a)(17) limits would not be pro-rated in this case.  

Thank You...as far as the 402g, if the 415 limit is only $14,250 wouldn't by default (only pretax contributions) the participant would not be able to contribute $19,500 as it would exceed the 415 limit. 

7 hours ago, justatester said:

Thank You...as far as the 402g, if the 415 limit is only $14,250 wouldn't by default (only pretax contributions) the participant would not be able to contribute $19,500 as it would exceed the 415 limit. 

If they are catch-up eligible they can exceed the 415 limit by the catch-up limit. So if your prorated 415 limit is $14,250 and they are 50 or over they could contribute an additional $6,500 for a total of $20,750.

so if they are not age 50, they are stuck with $14250 in deferrals - not the 19500?? That is my question that I had posed to me today?

Even less if they get a match. 415(c) limit is the most they can be allocated.

Is there some reason to not make it retro active to 1/1 to get full 415 limit? I'm sure there are good reasons why not to make it retro to 1/1 but in many cases you can take advantage of the higher limits without adding much if anything in the way of additional costs.