401(k) Rescue, the Ekon Benefits 401(k) Fix-It Series, describes the most common 401(k) mistakes as determined by the IRS. We provide explanations of common mistakes, suggested prevention techniques and recommendations on correction methods.

Common Mistake #3: Using the Incorrect Definition of Compensation for Allocation or Deferral Calculations

The definition of Compensation in your plan document plays a critical role in the operation of your 401(k) plan. Compensation typically refers to any form of pay an employee receives from the employer for services rendered during a given year, such as:

• Wages or salary
• Commissions
• Tips
• Fees for professional services
• Fringe benefits
• Bonuses

However, each plan defines Compensation differently. It’s essential to familiarize yourself with the plan’s specific definition of Compensation to avoid common pitfalls, such as excluding bonus payments from deferral and employer contribution calculations. Also, be sure to review plan provisions related to:

• Bonuses
• Post-severance payments
• Car allowances
• Fringe benefits
• Job title-based limits on Compensation

Some plans include multiple definitions of Compensation for different purposes, such as:

• Calculating profit-sharing allocations
• Performing discrimination testing
• Determining payroll-based deferrals and employer matches

Additionally, the IRS limits the amount of Compensation recognized for plan purposes. For example, in 2024, the maximum Compensation considered was $345,000, (subject to annual cost-of-living adjustments).

Consequences of Incorrect Compensation Definitions

Using an incorrect definition or amount of Compensation for allocations and deferrals can lead to incorrect contributions. This may result in:

• Excess contributions if too much compensation is considered
• Under-contributions if too little compensation is considered

It’s crucial that the definition of Compensation used in plan operations exactly matches the plan provisions and is communicated to all relevant service providers to ensure accurate calculations.

How to Prevent This Error

To avoid this issue, regularly compare the definition of Compensation found in the plan summary with the amended Plan Document. At the end of each year, verify that the correct definition has been provided to all relevant service providers to ensure contribution calculations are accurate.

Correcting the Error

If an error is made by using the incorrect definition of Compensation, it’s important to correct it promptly. Here are steps to take:

1. Excess Deferrals: If an incorrect definition results in excess deferrals, the excess amount plus earnings should be distributed to the affected participant.
2. Under-Contributions: If Compensation was incorrectly excluded, corrective contributions may be required to make up the difference.

In all cases, corrections should place affected participants in the position they would have been in had the error not occurred.

For a complete listing of the most common 401(k) mistakes, please visit the IRS 401(k) Plan Fix-It Guide. For assistance in correcting a plan error, please contact Ekon Benefits at (314)367.6555 or info@ekonbenefits.com.