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Will 2020’s Irregular Compensation Affect Retirement Plans?

Practice Management

The year 2020 provided unique circumstances. Among them are employers that are not paying bonuses this year but whose employees nonetheless have been logging overtime. A recent blog entry examines whether such a scenario has consequences for the employer’s retirement plan. 

In “Overtime Is Up & Bonuses are Down: Will This Year’s Irregular Compensation Impact our Retirement Plan?,” an entry in the DWC 401(k) Q&A Blog, DWC examines a situation in which an employer sponsors a 401(k) plan and provides a company matching contribution. The plan says that calculating the match, only employee base pay is considered—bonuses and overtime are not. This year, the employees have been working more overtime than before but the employer does not expect to be paying as many bonuses as in previous years. 

“When it comes to excluding certain forms of compensation when calculating company contributions to the 401(k) plan, budgeting is one of the main drivers we hear,” writes DWC. It suggests that plan language such as that in this scenario can help in budgeting. However, while it may offer ease of administration in one sense, it also carries with it a complication. 

To wit: DWC cautions that such a plan design spells the need to apply the compensation ratio nondiscrimination test. This test, notes DWC, compares the average included compensation for highly compensated employees (HCEs) to that of non-HCEs. They add that the plan must pass a bright-line test each year that there are excluded forms of pay. Furthermore, simply passing the compensation ratio test in one year does not necessarily mean that a plan will pass it in another.

2020 Circumstances

In a year such as 2020, in which there is increased overtime but reduced bonuses as for the employer described initially, the average included compensation for the HCEs likely will surpass that of the non-HCEs, DWC warns.

For non-safe-harbor plans, they advise, a plan can use one definition of pay to calculate matching contributions and a different definition to perform nondiscrimination testing such as the annual ADP/ACP test. Safe harbor plans, however, need to use the definition used to calculate the match to pass the compensation ratio test, DWC says. “This means there are real corrections necessary,” they note, adding, “the gist is that you must amend your plan to expand the compensation that is included and then make the additional company contributions that correspond.” 

“It’s important to make sure that the definition of compensation is within reason both numerically and circumstantially,” says DWC.