401(k) Withholding on Holiday Bonuses

The holiday season is a time for giving, and many employers reward their employees with a holiday bonus. However, the question arises: Are employee bonuses subject to the same 401(k) withholding as regular wages? The answer depends on your Plan’s Definition of Compensation and any special treatment of bonus compensation.

What is Compensation?

Compensation typically refers to any payment made to an employee for services rendered, including wages, salary, fees for professional services, commissions, and bonuses. However, a plan’s specific Definition of Compensation—as outlined in its governing Plan Document—may include or exclude certain types of pay, such as bonuses.

If Your Definition of Compensation Includes Bonuses

If your Plan’s Definition of Compensation includes all forms of compensation or does not specifically exclude bonuses, an employee’s bonus will be subject to their normal elected deferral rate.

Example:
Adam works for Company A, which includes all forms of compensation in its Definition of Compensation. Adam’s elected deferral rate is 10%. When Adam receives a $1,000 bonus, $100 (10% of his bonus) will be deferred into his 401(k) account.

If Your Definition of Compensation Excludes Bonuses

If your Plan excludes bonuses in its Definition of Compensation, 401(k) deferral elections will not apply to employee bonuses.

Example:
Bridget works for Company B, where the Plan Document specifically excludes bonuses from the Definition of Compensation. Bridget’s elected deferral rate is 12%, but she receives a $1,000 bonus. Because the Plan excludes bonuses, no 401(k) withholding will occur.

If Your Plan Allows for Different Deferral Rates on Bonuses

Some Plans allow employees to elect a separate deferral rate for bonuses, different from the rate used for their regular wages.

Example:
Chris works for Company C, where the Definition of Compensation includes bonuses, and employees can elect a separate deferral rate for bonuses. Chris has elected a 15% deferral rate for his wages and a 50% deferral rate for his bonus income. When Chris receives a $1,000 bonus, $500 (50% of his bonus) will be deferred into his 401(k) account.

In conclusion, 401(k) withholding for bonuses depends on your Plan Provisions, including the Definition of Compensation. If your plan fails to apply the correct definition of compensation when calculating deferrals or employer contributions, this is considered an operational failure. Under EPCRS (Rev. Proc. 2021-30), it may be eligible for correction through the Self-Correction Program (SCP) or the Voluntary Correction Program (VCP), depending on the circumstances.

Straight From the Source

For more information on correcting compensation-related failures, see the IRS 401(k) Plan Fix-It Guide: https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-you-didnt-use-the-plan-definition-of-compensation-correctly-for-all-deferrals-and-allocations