FLASH IN THE PLAN:
COMPENSATION – THE BACKBONE OF PLAN ADMINISTRATION

By: Alison J. Cohen, Esq.

If you have not already completed your annual census data collection process, it is critical that you pay close attention to the definition of “Compensation” in your Plan document. One of the most common failures that we see in our work with plan sponsors is the failure to follow the Plan document terms with respect to Compensation. This can mean that the plan sponsor either included, or excluded, certain types of compensation when calculating contributions and benefits.

Start with the Plan Document

“Compensation” will be defined in your Plan document.  There should be a general definition of Compensation, which will refer to one of three different Internal Revenue Code (“IRC”) Sections – 415, 3121 (also called Form W-2 Compensation), and 3401(a). You should talk to your third-party administrator (“TPA”) or accountant about what types of payments to employees are included and excluded in the definition your Plan uses.

But wait! There’s more! While that may be the starting point, the Plan may further include, or exclude, additional types of earnings from Compensation for benefit purposes. This can include things like the payout of Paid Time Off (“PTO”), accrued PTO, or compensation paid after date of termination. Other common amounts not counted for Plan purposes can include compensation paid prior to when the participant actually entered the Plan. If you are unsure what your Plan document says with respect to the definition of Compensation, you should talk to your TPA.

Watching for Common Exclusions

The most common mistakes that we see from our clients are bonuses, commissions, and reimbursements.  Reimbursements include things like moving expense reimbursements, transportation benefits, tuition reimbursements, employer-provided cell phones, and educational assistance.  See Internal Revenue Service Publication 15-B for a full list of these types of fringe benefits/reimbursements.

One thing that makes this difficult is that some plans include some or all of these types of compensation, while others exclude them.  Knowing what your Plan says is what is important.

How to Take Steps to Prevent Mistakes in Compensation

It is important to review how your payroll vendor is coding the various pay categories, and then how that coding is being interpreted when Compensation is reported to your recordkeeper or TPA.  We have found that some plan sponsors have 50 or more different pay codes set up in the payroll system.  Getting a report that defines each of these pay codes, and advises whether they are eligible for qualified plan purposes, is a good first step.  (Also, be careful about throwing unusual compensation into a pay code as “close enough.” We had a client classify a type of includible compensation in a pay code that was excludible, causing an error in the plan that the IRS identified when the plan was examined.)

What are the Consequences of Missing Payroll Codes?

When you report the incorrect compensation amounts to your TPA, everything that is produced as a result of that data will be incorrect. This includes Average Deferral Percentage (“ADP”) testing, Actual Contribution Percentage (“ACP”) testing, employer contribution allocation calculations, and determinations of whether maximum contributions (such as matching contributions limited to a given percentage of compensation) are exceeded. If these discrimination testing and allocation calculations are done incorrectly, the result can be that the plan sponsor will need to fund additional contribution amounts or incur complications as part of the preparation of the Form 5500 and independent audit, as applicable.

Conclusion

If you discover that you have not followed the terms of the Plan with respect to your definition of Compensation, you have an operational failure according to the IRS. This failure can be corrected – and it’s always better to find the mistake and fix it yourself, rather than having it arise in the middle of an IRS examination. Call us to help you resolve this kind of problem. Remember, we are your ERISA solution!

Talk to Your TPA:

Most retirement plans are required to adopt the interim amendment commonly called the “SECURE Amendment” by the end of 2026. This is not the usual interim amendment that can be adopted by your document provider on the plan sponsor’s behalf. It requires a number of historical elections to be documented that were made as early as 2020, so the plan sponsor has to be actively involved in the process. If you haven’t already spoken with your TPA about this amendment, you should do so sooner rather than wait until the end of the year.

Key Dates:

4/1 – Distribution deadline for those who are required to receive their first Required Minimum Distributions

4/15 – Employer contribution deposit deadline for c-corps and sole proprietors, without extension (3.5 months after plan year-end)

4/15 – Distribution deadline to correct any deferrals in excess of the annual 402(g) limit

6/30 – For EACA plans, failed ADP/ACP testing refund deadline (6 months after plan year-end)