(b)lines Ask the Experts – Different Definitions of Compensation

March 12, 2013 (PLANSPONSOR (b)lines) – “Our 403(b) plan document contains several different definitions of compensation for purposes of determining the amount of the employer discretionary, employer matching and elective deferral contributions to be made on behalf of participants.

“Not only is each definition different from the other, each one contains a distinct “laundry list” of inclusions/exclusions. Beyond the fact that all of this is needlessly confusing, should I otherwise be concerned?”  

Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:  

The Experts believe you should be concerned BECAUSE the definition is confusing! The Internal Revenue Service (IRS) has repeatedly stated that one of the most prevalent operational failures discovered upon audit is the use of operational definition of compensation that is not consistent with the plan document definition for allocation of the different contribution types. Definitions that differ by contribution source, and contain several exclusions, can serve as a recipe for compliance problems. Each paycode must be reviewed to determine if it is included/excluded from each plan document definition, which, in the Experts experience, can be prone to error, as pay codes are often added/changed on a regular basis. In addition, although a plan sponsor’s benefits department may be well-versed in the plan document definitions, others who are involved with administration of the pay codes (payroll, HRIS) may not be as knowledgeable.  

Thus, best practice is to keep the plan document definition of contribution for allocation purposes as simple as possible, unless there is a compelling business reason to exclude different pay codes that outweighs the potential audit issues. Also, in general, many exclusions must be tested for nondiscrimination so that compensation of non-highly compensated employees (NHCEs) is not disproportionately excluded. And finally, as pointed out in another Ask the Expert column (see “Ask the Experts: Universal Availability and Excluding Compensation”), plans that exclude certain categories of pay from the definition of compensation used to calculate the amount of elective deferrals risk running afoul of the Universal Availability requirement.  

Good luck with simplifying your compensation definition!  


NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.