Defining Compensation
One of the biggest mistakes that employers sponsoring a defined contribution (DC) plan make is not including all types of compensation when calculating contributions and the company match. It’s also important for discrimination testing and determining who is a highly compensated employee (HCE). A California based TPA lays out the basics for plan sponsors in plain English. This guide will help sponsors in defining compensation.
Basic compensation includes:
- Wages reported in W2 forms
- Income subject to taxation
- Compensation paid for professional services
Other types of compensation can include:
- Deferrals to retirement plans
- Severance paid within two and one-half months of separation
- Unused vacation pay
Defining compensation that can be excluded for the purposes of determining contributions to the company’s retirement plan includes:
- Pre-enrollment pay
- Fringe benefits
- Overtime
- Bonuses
- Commissions
Another TPA explains that along with statutory definition of compensation, employer can elect alternative definitions that does not satisfy one of the safe harbors as long as it is reasonable and does not discriminate in favor of the highly compensated employees.
To satisfy this requirement, the plan must demonstrate that the average percentage of total compensation included under the alternative definition of compensation for an employer’s highly compensated employees does not exceed by more than a de minimis amount the average percentage of total compensation for the non-highly compensated employee group.
For example, if the employer uses regular pay as the definition of compensation and only non-highly compensated employees receive additional compensation (overtime), then the definition would be considered discriminatory. On the other hand, if only highly compensated salesmen were receiving additional pay), then the definition would most likely not be discriminatory.
Its’ important for companies to clearly define what should be included as compensation for their DC plan and make sure that the company follows it. Deferral mistakes happen and although the DOL has levied a lot of fines and has picked up their enforcement activity, there are methods to voluntarily correct errors if employers sponsoring an ERISA plan take timely action. One way to avoid fines and other liability is to self report under the Employee Plan Compliance Resolution System (EPCRS).
