Catch-Up Contributions Must Exceed Some Limit

Background: Definition of Catch-Up Contributions

Individuals who are age 50 or over at the end of the calendar year can make annual catch-up contributions to their 401(k), 403(b), and governmental 457(b) plans in the amount of $7,500 in 2023 and 2024. By definition, catch-up contributions must be contributed IN ADDITION to the lesser of:

• the IRC Section 402(g) limit of $23,000 or $22,500 for 2024 and 2023, respectively,
• a plan imposed limit, or
• the maximum deferral amount permitted to each Highly Compensated Individual by the Aggregate Deferral Percentage (ADP) discrimination test.

To reiterate, the Internal Revenue Service website indicates that:

Elective deferrals are not treated as catch-up contributions until they exceed the limit of $23,000 in 2024 ($22,500 in 2023; $20,500 in 2022; $19,500 in 2020 and 2021; $19,000 in 2019) or the ADP test limit of section 401(k)(3) or the plan limit (if any). Click here to learn more.

The Mechanics Should Follow the Rules

It has been brought to our attention that some payroll companies recommend that plan sponsors code the system to allocate a part of EACH participant contribution to the catch-up source, starting with the first payroll of the year. Unless a participant is contributing 100% of his/her pay and the first paycheck of the year exceeds the lowest of the three possible limitations, there is no part of a participant contribution withheld at the beginning of the year that should be considered a catch-up contribution. As a practical matter, if the participant remains employed for the full year, the end result will not make a difference, since the participant will have achieved the maximum limit under IRS Code section 402(g) of $23,000 for 2024, or if lower, the amount permitted by the plan document or the ADP test, plus the maximum catch-up contribution amount of $7,500. However, if the participant terminates employment mid-year, the amounts classified as a catch-up will be misclassified. This makes a difference because the catch-up is not subject to any of the maximum limits or the discrimination test, and some plans do not match the catch-up contribution. The misclassification could lead to an erroneous ADP test or to the participant not having received the correct amount of match contribution from the employer.

Example – Coding Participant Elections on the Payroll Software

When the payroll software has two separate codes for regular deferrals and for catch-up contributions, some employers allocate the deferral withholdings for each payroll period partially to the regular deferral source and partially to the catch-up code. For a participant who contributes the maximum deferral and catch-up from his monthly paychecks, the 2024 withholdings would be:

As illustrated, if the participant stays employed all year, there is no effect on the classification of total contributions between regular deferrals and match at the end of the year. The 402(g) maximum of $23,000 and the maximum $7,500 catch-up will have both been achieved. There is no impact on the data submitted for discrimination testing, and if the plan sponsor does not match the catch-up, the participant will have received the full match specified by the plan’s allocation formula.

But There’s A Catch if the Participant Terminates Mid-Year

On the other hand, if the participant had left the company or the coding was done in this manner for a newly eligible participant, the participant’s account would show a catch-up contribution, even though the deferral limit had not been reached, as follows:

What’s the Catch?

Catch-up contributions are not subject to discrimination testing. Excluding contributions attributed to the catch-up source erroneously from the census data submitted to the third party administrator can cause the test results to be incorrect. Whether the above participant is a non-highly compensated or a highly compensated individual, the misclassification of regular deferrals as catch-up contributions affects the results of the discrimination testing. If the ADP test passes with ample margin, or the plan is a safe harbor plan, this contribution classification error may not have much impact. However, if the test passes by a hair or if the test fails, then having included the misclassified catch-up contributions would yield a different result. Additionally, if the plan does not match catch-up contributions, the plan sponsor may need to allocate an additional match contribution corresponding to the misclassified catch-up contributions. Additional match dollars are needed to catch up the misclassified catch-up’s match. That’s the catch!