When administering their 401(k) plan, one of the most common mistakes that employers make is allocating plan contributions to a participant account using the incorrect employee compensation. The most common occurrence is when an employer mistakenly excludes forms of compensation such as bonuses, overtime, or commissions that are defined as eligible compensation in the company’s plan document. Mistakes of this nature may require the employer to make retrospective corrections to the affected participants. The process of making these corrections, depending on the gravity of the situation, can often be very time consuming and expensive for employers to correct.
All 401(k) plan documents should define the compensation that the employer will use to allocate plan contributions to participants. The most common forms of compensation are W-2, Section 3401, and 415 safe harbor. All three of these options can either include or exclude post severance compensation. Choosing the W-2 option is most common because they are most easily obtainable. However, all plans are not built the same, so the plan’s form of compensation may differ.
Once the definition of compensation has been reviewed in the plan document, an employer should go through each pay code to determine what qualifies as an eligible and ineligible compensation. There is plenty of source material available that the Internal Revenue Service provides that would be useful in this determination. Once eligible and ineligible contributions are determined, an employer should review some of the employee contributions to ensure they are calculated properly. An effective way of doing this would be to randomly select a few participating employees during a specific pay period and recalculate their deferrals.
As a recommendation, consulting with the plan’s Third-Party Administrator or an ERISA attorney would be greatly beneficial to ensure that the current contributions are properly being calculated according to the plan. An experienced administrator or attorney can provide peace of mind and answer any remaining questions that may arise. Although the process may seem strenuous, taking the time to make sure that the plan complies can save on time, money and headaches in the future.