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Including or excluding incentive pay can affect employee-deferral and employer-matching contributions
With the IRS's release of the 2017 401(k) contribution limits and the annual compensation cap for calculating deferral and matching contributions, plan sponsors may want to revisit how their plan documents define "compensation"—and how that definition (or definitions) affects employee participation and savings rates.
Sponsors of 401(k) plans have some leeway in selecting which kinds of employee compensation to use for determining employee-deferral and employer-matching contributions, said Martha M. Sadler, executive vice president at Newport Group, a retirement plan and executive benefits consultancy in New Bern, N.C.
"Internal Revenue Code [IRC] section 415 provides three alternative definitions of compensation in qualified retirement plans," said Sadler, who spoke on Oct. 23 at the annual conference of the American Society of Pension Professionals & Actuaries (ASPPA) in National Harbor, Md. Those options are:
"Plan documents must provide the specific definition of compensation" for specific purposes, Sadler said. In addition, IRC section 414(s) requires that a nondiscriminatory definition of compensation be used when performing annual nondiscrimination tests—the actual deferral percentage (ADP) test and actual contribution percentage (ACP) test that a qualified retirement plan must satisfy.
Common adjustments to compensation include:
But exercise caution because "non-safe harbor compensation adjustments may turn out to be discriminatory" by impermissibly favoring highly compensated employees and should be tested for compliance with nondiscrimination tests, Sadler said.
[SHRM members-only toolkit:
Designing and Administering Defined Contribution Retirement Plans]
Beware the Pitfalls
Practices that can complicate nondiscrimination tests include:
Common compensation errors, she noted, include:
"Mistakes found early are usually cheaper to correct," she added.
Related SHRM Article:
In 2017, 401(k) Contribution Limit Unchanged for Employees, Up for Employer, SHRM Online Benefits, October 2016
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