Each year, it is interesting to see which compliance scenarios trending. Sometimes, we see new types of questions come to the surface more frequently, while there are more familiar questions in other years. Given that 2020 was anything but a normal year, we were curious what we would see now as we look back on the year of lockdown while working through year-end testing and contribution calculations with our clients.
This year, it has been a little bit of both – some new and some tried and true. Although we still have a few more weeks before April 15th and the end of another busy season, we are bringing you this year’s crop of interesting compliance scenarios.
Match True-Up Contributions
It seems that this one makes an appearance on the list every few years. Here are some of the questions:
- What is a true-up and why do I have to make one?
- How can we avoid true-ups?
- What if we want to make sure everyone receives a “full” match?
Let’s take them in order. For starters, a true-up contribution is typically required in a plan that specifies the match for the year is determined based on full year compensation and deferrals, but the company actually calculates and deposits the match each pay period. If a participant’s deferrals exceed the match formula in any given pay period but not for the full year, that participant is entitled to a true-up match.
Eleanor defers 8% of her pay for the first half of the year and 0% for the second half, yielding an annual deferral rate of 4%. The safe harbor match formula is 100% of the first 4% each person defers. If the company calculates the match each pay period, Eleanor will only be matching on half of her deferrals for the half of the year she deferred. However, since Eleanor’s annual deferral rate is only 4% of her annual pay, she is due an additional match at year end. That is a true-up.
We go into more detail and provide additional examples here.
There are two primary ways to avoid true-ups, and both have distinct pros and cons. First, you could wait and fund the match after year end. One calculation, one deposit, that’s it. However, this could lead to negative PR with participants who are used to seeing that match hit their accounts each pay period. They may also be less than thrilled at losing out on the opportunity to invest those dollars earlier, especially when the market is doing well. Another potential downside is cash flow. For some companies, it is much easier to budget for smaller match deposits each pay period rather than a much larger one after year end.
A second option for avoiding true-ups is to amend the plan to specify that the match is determined separately for each pay period. Then it doesn’t matter if deferral rates fluctuate throughout the year, because each pay period is treated as its own stand-alone computation period. No year-end calculation means no true-up due. The downside here is that anyone who defers more than the match formula in any given pay period will lose out on part of the match benefit. Since it is often the plan’s highly compensated employees that defer over the match formula, this could lead to negative PR of a very different kind.
So, what if you want to make sure everyone receives the full annual match benefit? The first thing is to confirm your plan does, indeed, provide for an annual match. If it’s currently set to pay period (or monthly, quarterly, etc.), a plan amendment may be in order. After that, really the only way to avoid true-ups while sticking with the annual match is to use what is sometimes called the “year-to-date minus previous” method. This requires calculation of the match based on the year-to-date deferrals and compensation with each payroll period. The amount to deposit is the year-to-date match MINUS what has already been deposited for the year.
The next logical question is likely whether it can be discretionary so that you can true-up in some years but not in others. When it comes to safe harbor matching contributions, the is a definite no. The reason is that every element of the safe harbor match formula must be specified in the plan document, including the time period used to calculate it. For non-safe harbor plans, it is possible to leave it discretionary, though doing so leads to additional reporting and disclosure requirements.
If none of these options sound good, tell the participants to pick a deferral rate that maximizes in the final pay period and stick with it!
Trusts as Owners
One of the first things to confirm when doing testing and calculating contributions each year is whether the plan sponsor is related to any other companies through overlapping ownership such that they must be combined for compliance purposes. In addition to looking at direct company ownership, there are some situations in which something owned by one person or entity is attributed to another person or entity. This most often comes into play between family members – spouse to spouse, parents to children, etc.
This year we saw an uptick in situations where an individual doesn’t own the plan sponsor; a trust that the individual created for estate planning purposes is the owner. There is nothing at all problematic about that except that it brings those attribution rules into play. Although attribution among family members is generally straight-forward, dealing with trusts (or any non-person entity for that matter) gets much more complicated quite quickly. We will explore this topic in more detail in a future post, but the gist is that attribution varies based on the specific type and provisions on the trust. Is it revocable or irrevocable? Who is the beneficiary? Are there conditions the beneficiary must satisfy? Those are just a few of the many questions that can come into play. And since trusts are mostly governed by state law, the answers to those questions may lead down different location-based paths.
Trust us when we say that this is an area where keeping that estate planning attorney’s phone number handy is probably a good idea.
Suspense and Forfeiture Accounts
This is another one that comes up every so often, and in all fairness, it does get a little more in the weeds than it seems like it should. Every so often, a plan may hold amounts that are not allocated to a specific participant. The most common instance is when a participant who is not fully vested terminates, takes a distribution of the vested portion, and leaves the non-vested portion behind. That is called a forfeiture and should be moved to a forfeiture account within the plan. The plan document specifies how and when forfeitures can/should be used. Generally, there are three options:
- Pay allowable plan expenses;
- Offset company contributions; and/or
- Allocate as additional company contributions.
If the forfeitures are not used timely (usually by the end of the next year), they must be allocated as additional company contributions.
Suspense accounts, on the other hand, are typically necessary when a company accidentally pre-funds more of a contribution than intended or the plan calls for. Think of a miscalculation of a company matching contribution that results in a participant receiving a little too much. Unlike the various options that apply to forfeitures, suspense dollars must be allocated as company contributions. The only question (as we will see below) is which year they must be allocated.
This requirement exists to prevent companies from using the plan to improperly “shelter” cash. Qualified retirement plans enjoy significant protections against creditors, legal judgments, etc. Without a rule like the one we are discussing here, it would be possible for a company that is facing some sort of judgement to park a bunch of money in a plan holding account to keep it sheltered under the guise of pre-funding the next 5 or 10 years’ worth of matching contributions.
Since there are different requirements for using suspense dollars, they should NEVER be combined with forfeitures in the same holding account. Also, timing really matters! Let’s look at a couple examples for the 2020 plan year:
Company X’s last pay date of the year is December 15th. They make their final match deposit for the year ($5,000) a few days later on the 18th, bringing the total match deposited for 2020 to $50,000. As part of our 2020 annual compliance review in February 2021, we calculated the total annual match to be $48,000, meaning the company overfunded the match by $2,000. Since the full amount of the match was deposited before year-end, the extra $2,000 MUST be allocated an additional company contribution for 2020.
We have the same facts except that X made it’s final $5,000 match deposit just after year-end on January 4, 2021. Because the deposit made after year-end was more than enough to cover the excess funding ($5,000 deposit vs. $2,000 in over-funding), the excess can either be allocated as an additional contribution for 2020 or used toward the 2021 match.
Two important takeaways:
- Keep forfeitures and over-funded company contributions in separate plan holding accounts. Recordkeepers might not always be aware of the difference, so it is critical to work together to ensure this is handled properly.
- If you are funding any company contributions throughout the year, accuracy is key. And just to give yourself some extra comfort, consider holding off on making that final deposit or two until after the end of the year