Less than a year from now, Plan Sponsors are required to restate their Defined Contribution Plans by April 30, 2016. As Plan Sponsors work toward restatement, there’s virtually no better time than now to ensure that the daily administration of the Plan is congruent with the Plan Document. There’s a variety of examples where the provisions of the Plan Document don’t necessarily align with how the Plan has been administered in practice. One of the most common inconsistencies occurs with matching contributions. Are current contributions being matched on a payroll by payroll basis or at year end? Does the administrative procedure adhere to the current Plan Document? Is it possible the company match has fallen below the stated formula? As a Plan fiduciary, these are all valid questions that need your attention. Every year there are certain circumstances that could lead to the company match contribution falling lower than what is stated in the Plan Document. In these cases, a year-end true-up would be necessary in order for a participant to receive the full company match. The two scenarios below reflect instances where the company match may not be what it seems.
Scenario One: Participant Changes Deferral Rate During the Year
The ideal situation for participants in their working years is to defer enough to receive the full company match and to contribute to the IRS maximum. However, the reality is many participants do not max out their contributions for a number of reasons and, more often than not, they may change their deferral percentage mid-year for one reason or another. Below is an example of how changing a deferral rate mid-year may affect the company match.
The Plan Document for XYZ Corp. states that the company will match dollar for dollar up to 6% of total pay for the year. For Participant A, making $50,000 a year and deferring 6%, the match would equal $3,000 ($50,000 x 0.06). Now let’s assume that for the first six months of the year, Participant A defers 4% ($25,000 x 0.04 = $1,000) and the second half of the year Participant A defers 8%. While you might think Participant A still receives the full $3,000 match, recall that the match formula only allows the company to match dollar for dollar up to 6% so during the second half of the year, Participant A only receives the match on the first 6% of his 8% deferral ($25,000 x 0.06 = $1,500).
Despite deferring a total of 6% during the course of the year (entitling Participant A to the full company match of $3,000), XYZ Corp. matches contributions on a payroll period basis so the participant only receives $2,500 (or 5%) in company match. Consequently, XYZ Corp. needs to make an additional matching contribution of $500 to the participant’s account. This true-up contribution may be made as late as the deadline (including extensions) for filing XYZ Corp.’s federal tax return.
Scenario Two: Participant Front-Loads Contributions
For most participants, saving for retirement can be a struggle. There are others that can, and do, save up to the IRS maximum. A common problem with this group is that they end up maxing out their contributions earlier in the year which may decrease the match received.
Let’s again assume the Plan Document for XYZ Corp. states that the company will match dollar for dollar up to 6% of total pay for the year. For Participant B (under the age of 50), making $120,000 a year and deferring 6%, the annual match contribution totals $7,200 ($120,000 x 0.06). If Participant B defers 20% at the beginning of the year, he or she would max out before the end of July (maximum 401(k) elective deferrals for 2015 is $18,000). At this accelerated rate, however, the company would have only matched for roughly the first six months or $3,600. Once again, if the Plan Document states that match contributions are based off annual pay and not per pay period, a true-up payment of $3,600 would be required to stay in compliance.
The two examples above both share one common element—both Plan Documents state the match will be calculated based on annual salary. However, in both cases the Plan Sponsor was matching on a payroll basis. With the Plan restatement process in full swing, 2015 provides an opportune time for Plan Sponsors to reevaluate their Plan Documents and administrative procedures. As a fiduciary, it is critical to ensure that you are following the Plan Document in practice and not just on paper.
For more information on these and related topics, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
