Earlier this month the Democratic and Republican caucuses took place in Iowa with each of the 99 counties in Iowa hosting its own convention. Since 1972, the Iowa caucuses have been the first major electoral event of the nominating process for President of the United States.
While only about 1% of the nation’s delegates are chosen by the Iowa State Convention, the Iowa caucuses have served as an early indication of who will continue their candidacy for president.
At an expected cost of nearly $50M*, the Iowa caucuses are a huge boom to the local economy with hotel rates in Des Moines approaching those you’d typically find in New York City (assuming you’re actually able to find a hotel room). Those employers with employees covering this event should expect to see sizeable expense reports in the near future.
While many employers had expected to spend big money covering this event some may be looking to reduce costs in other areas – including their qualified retirement plans. One way some may do this is by limiting the types of compensation that may be taken into consideration in determining contributions under their retirement plans for purposes of lowering their total cost.
As discussed in our last blog, a plan is required to use a definition of compensation that is deemed nondiscriminatory by the IRS (e.g. gross W-2 pay) when determining total contributions. However, some employers may prefer to use a definition that excludes bonuses, overtime or commissions as it makes up a significant portion of total income and can increase the amount of total contributions.
While the exclusions may be allowed, the employer should take steps to make sure the definition of pay is reasonable and does not unfairly discriminate against their non-highly compensated employees or NHCE (generally those earning less than $120,000 annually).**
In order to allow the exclusions, additional testing may be necessary to make sure that the NHCE have, as a percentage of total pay, less compensation excluded than the HCE to ensure the definition of pay is nondiscriminatory. If the HCE have 3% of pay excluded but the NHCE have 10% of pay excluded the definition of pay will generally be considered discriminatory and cannot be used.
(Un)Safe Harbor 401(k)?
Employers who have adopted a safe harbor 401(k) plan design feature should be even more cautious in regard to compensation exclusions due to the complexities it may create. A safe harbor 401(k) plan that is properly designed will satisfy most nondiscrimination plan compliance testing – provided the plan has used a definition of compensation that meets IRS “safe harbors” (e.g. pay reported on W-2).
A plan that excludes bonuses or overtime pay for example may also meet IRS safe harbors. However, additional testing will need to be performed to ensure that it does. If only an employer’s NHCE have compensation that is excluded in determining contributions the test may fail requiring potentially expensive corrections.
As a safe harbor plan that was initially designed to meet safe harbors, is it worth the risk and added expense?
When considering if your plan will exclude compensation in determining contributions under the plan it will be helpful to understand what impact the testing may have. While excluding compensation may save the employer some cost, the additional work that must be performed to ensure a nondiscriminatory allocation may not be worth the additional work.
** Amount indexed annually by the IRS
The subject matter in this communication is provided with the understanding that The Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
t16020301vl – 2/2016