When we hear the word “compensation,” many of us think about the dollars that are reported as gross pay on our check stubs. Although, in many instances, that is not what is considered “compensation” for retirement plan purposes. There are multiple definitions of compensation, and depending on the definition your plan uses, the results can be very different.
There are three definitions of compensation that can be used in a plan.
- 415 compensation – this refers to an IRS code section that defines the components of this compensation. It is often referred to as gross compensation because it includes almost all types of pay (however it does exclude severance pay, workers compensation, non-taxable fringe benefits and expense reimbursements).
- 414(s) compensation – this again refers to an IRS code section that defines the components of this compensation. Often referred to as nondiscrimination compensation, this must be used for all plan nondiscrimination testing.
- Reasonable compensation – when one of the previous two types of compensation is not required, this definition may be used. Compensation can be modified by such items as excluding overtime and bonuses, excluding compensation prior to an employee meeting plan eligibility requirements or limiting compensation to a certain dollar amount.
The following is a sample list of what compensation is approved for various tests, plan limits and allocations in a retirement plan.
|Determine Key EEs||Yes||No||No|
|Plan deferral limit||Yes||Yes||Yes|
|Soc Sec Disparity||Yes||Yes||No|
|Safe Harbor contribution||Yes||Yes||No|
|Top Heavy minimums||Yes||No||No|
As you can see, compensation must be carefully considered in all aspects of retirement plan design. Regulations governing compensation are complex, but it is important to know what definition is used for specific aspects of the plan. There are times when the appropriate use of compensation can provide a greater benefit to owners and highly compensated employees.
Compensation means different things depending on the plan provision or law being interpreted. Sikich Retirement Plan Services can help you determine the appropriate compensation definition when designing a retirement plan based on the Company’s goals and objectives.