Employer contributions are made by the Employer for the benefit of designated employees. Among other things, the Adoption Agreement will identify the types of employer contributions that the Plan provides, whether contributions are mandatory or discretionary, and what the eligibility requirements for employees to receive each type of contribution are.
Annual Combined Limit on Elective Deferral and Employer Contributions
Section 415(c) of the Internal Revenue Code places a ceiling on total contributions that may be made to an employee’s retirement plan. This total contribution includes the employer and employee contribution and for 2012 is capped at 100% of an employee’s compensation or $50,000, whichever is less. This number is adjusted annually for cost of living increases.
- Matching. Also known as “elective” contributions, the Employer matches what the employee “elected” to defer up to a certain dollar amount or percentage of compensation. Contributions can be designated as regular and they can also be designated as a qualified (QMAC) or safe harbor contribution, which helps the Plan satisfy certain nondiscrimination test requirements.
- Nonelective. All Participants who meet the eligibility requirements receive this contribution. Contributions can be designated as regular and they can also be designated as a qualified (QNEC) or safe harbor contribution, which helps the Plan satisfy certain nondiscrimination test requirements.
- Profit sharing contributions are a type of nonelective contribution.
- QACA Contributions. If the Plan includes the Qualified Automatic Contribution Arrangement (QACA) feature of automatic enrollment, a mandatory matching or nonelective contribution is made to all eligible employees.
[COMPLIANCE CHECK]: The Safe Harbor provision has to be communicated to all employees every Plan year before the beginning of the year. The notice is required at least 30 days but not more than 90 days prior to the beginning of the Plan Year.
How are Employer Contributions Calculated?
Your Adoption Agreement states how employer contributions are calculated. It can be calculated based on a pre-determined or fixed percentage or dollar amount or the amount can be determined each year.
For matching contributions, you should be clear on how the formula for calculating the matching amount is applied. This is typically called something like “Period of Determination” or “Contribution Period” in your Adoption Agreement. If the matching contributions are made more frequently than for the contribution period (e.g., per the plan document the contribution period is “the Plan Year” and the Employer makes matching contributions “each payroll period”), the Employer must calculate the matching contribution with respect for the full period and make any additional “true-up” matching contributions.
Vesting of Employer Contributions
Vesting means that employees will vest, or own, a minimum percentage of their account in the plan each year. When employees are 100% vested in their account balance, they own 100% of it and the employer cannot forfeit, or take it back, for any reason (Note: employees are always 100% vested immediately in their elective deferrals). Vesting schedules can range so it’s important to be clear on how your Plan is designed. The schedule is also determined by the type of contribution made:
- Safe Harbor & Qualified Contributions are always 100% vested immediately.
- Regular Matching & Profit Sharing Contributions can be 100% vested immediately or an up to 3-year Cliff or up to a 6-year Graded vesting schedule can be assigned.
- QACA Matching & Nonelective Contributions can be 100% vested immediately or an up to a 2-year Cliff or Graded vesting schedule can be assigned.
Cliff vesting is when the employee becomes fully vested after a specified time (e.g., after 3 years of eligible service). Graded vesting is when the employee becomes partially vested in increasing amounts over an extended period of time (e.g., 20% per year).
Contributions Effect on Nondiscrimination Testing
Compliance testing is an annual IRS requirement for qualified plans. Based on the design of the Plan, some tests may not be required.
Qualified contributions help a Plan satisfy certain nondiscrimination tests. For example, if a plan makes a qualified contribution (QNEC or QMAC), the plan will satisfy ADP and ACP testing requirements; depending on if there are other types of contributions made (i.e., profit sharing) the plan may also satisfy Top Heavy testing requirements.
Since they are mandatory and are 100% vested immediately, Safe Harbor contributions allow the Plan to automatically pass the Top Heavy, ADP and ACP tests.
Regardless of the type of employer contributions, the 415 Limits Test and the 402(g) Maximum Deferral Limit Test are always required.
Making assumptions about the provisions of your retirement plan can spell disaster and earn you a first class ticket to a DOL audit. Whether you think your plan is running smoothly, it doesn’t hurt to complete a check-up of your plan and ensure that the Plan Administrator and payroll processor are on the same page. Because of the unique provisions that retirement plans can adopt, there are some common plan mistakes to be aware of:
- Not capping compensation at $250,000 when figuring contributions. Confirm whether your payroll processor automatically caps compensation at this limit or whether you have to monitor it yourself. Not capping compensation at this amount contributes to mistake #2:
- Exceeding the maximum percentage permitted under the terms of the plan. The maximum annual limit of the employee and employer contributions is $50,000 or 100% of compensation, whichever is less. Having multiple employer contribution types (e.g., matching plus a profit sharing contribution) can make it easier to reach these limits. Also remember that the limit is capped at 100% of compensation, so if someone receives compensation of $30,000 in a Plan Year, that person can receive at most $30,000 in contributions.
- Catch-up contributions included/excluded. Plans are permitted to be drafted to include or exclude catch up contributions in the match calculation. Confirm which option is applicable to your plan and confirm that your payroll processor has it set up properly.
- Improper eligibility dates. The date employees are eligible to make elective deferrals and receive employer contributions are not required to be the same. Confirm the eligibility requirements for each type of contribution (elective and employer contributions) and confirm that your payroll processor has all types set up properly.
- Submitting employer contributions under the incorrect money type. Whatever method the Plan utilizes to submit contributions to the recordkeeper (manually, file upload, direct feed from payroll provider, etc.) ensure that contributions are posted to the correct money type. Submitting a safe harbor matching contribution under the regular matching contribution type could result in improper distributions and vested account balances being provided to employees (a safe harbor contribution is 100% vested immediately whereas the Plan may have a 6-year vesting schedule on regular matching contributions). Compare your payroll records periodically (e.g., at the end of each quarter) with the information provided on the reports received from the recordkeeper to catch errors.
- Calculation of true-up/annualized match. DOL audits have revealed that plan sponsors are not interpreting the plan’s match formula in accordance with the plan document. Including or excluding of a full plan year “period of determination” is a trend that has increased. This may result in employees not receiving their full employer matching contribution. For example, the Plan defines the match computation period as the plan year. The Plan Sponsor contributes its match each payroll period based on what each employee defers in that payroll. At the end of the year, the Plan Sponsor does not true-up (annualize) the match because the Plan Sponsor did not understand the definition of the “period of determination.” Review your Plan documents and if this is applicable ensure that you true-up your contributions at the end of the year.