Tips and Traps of Compensation – Part II

Posted by Maria T. Hurd, CPA, RPA

Tips and Traps of Compensation: Part II – What’s the Catch with Administering Catch-Up Contributions?

Catch Up Contributions - 401k Audit

In the first part of our Tips and Traps of Compensation Series, we talked about The Trouble with True-Ups or Lack of True-Ups. Part II talks about administering catch-up contributions.

Definition  of Catch-Up Contribution

As stated on the IRS website, a catch-up contribution is, generally, an elective deferral made by a catch-up-eligible participant that exceeds a statutory limit, a plan-imposed limit, or the ADP limit (an “applicable limit”).

Coding Participant Elections on the Payroll Software

Based on the above definition, 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, there is no effect on the total contributions at the end of the year. For example, in the year 2019, a catch-up-eligible individual who gets paid monthly would end up with the maximum 402(g) limit of $19,000 and the maximum catch-up contribution of $6,000, as follows:

January $1,583.33 $500.00
February $1,583.33 $500.00
March $1,583.33 $500.00
April $1,583.33 $500.00
May $1,583.33 $500.00
June $1,583.33 $500.00
July $1,583.33 $500.00
August $1,583.33 $500.00
September $1,583.34 $500.00
October $1,583.34 $500.00
November $1,583.34 $500.00
December $1,583.34 $500.00
 
TOTAL $19,000.00 $6,000.00

 

What’s the catch?

Although the above coding methodology ultimately had no impact on contribution source classification or the discrimination testing, 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:

Participant leaves mid-year:
January $1,583.33 $500.00
February $1,583.33 $500.00
March $1,583.33 $500.00
April $1,583.33 $500.00
May $1,583.34 $500.00
June $1,583.34 $500.00
 
TOTAL $9,500.00 $3,000.00

 

Participant begins contributions mid-year:
July $1,583.33 $500.00
August $1,583.33 $500.00
September $1,583.33 $500.00
October $1,583.33 $500.00
November $1,583.34 $500.00
December $1,583.34 $500.00
 
TOTAL $9,500.00 $3,000.00

 

What’s the problem?

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, but if the test is close and the plan does not match catch-up contributions and has no true-up provision,  the misclassification could have a more significant impact.

That’s the catch!

 

Photo by Mike Rastiello (License)

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