Sponsors of 401(k) plans often fail to make the proper employer matching contribution called for under the terms of the plan document. Although there are any number of causes for this failure, a common one involves the timing of matching contributions.
A plan’s terms generally state that employer matching contributions will be a percentage of each participant’s deferrals, up to a specified level. Plans may describe these matching contributions in terms of either an annual amount or pay-period amounts. If an employer calculates its matching contribution on a pay-period basis, when the plan calls for an annual calculation, the sum of these pay-period amounts may not comply with the terms of the plan.
For example, assume Employer ABC sponsors a calendar-year 401(k) plan. The plan provides that ABC will make a matching contribution equal to 100% of the annual amount deferred by each participant, up to 6% of compensation. Therefore, any participant deferring at least 6% of pay should receive a matching contribution equal to 6% of pay. Participants are paid semi-monthly and the plan allows participants to change their deferral levels on the first day of each month.
During the 2011 plan year, ABC erroneously computed its matching contribution on a pay-period basis, rather than an annual basis. Michelle, a plan participant, received annual compensation of $50,000. She elected a 9% rate of deferral for the first half of the year ($25,000 x 9% = $2,250 in elective deferrals), but she reduced her deferral rate to 3% for the second half of the year ($25,000 x 3% = $750). Over the course of the year, ABC made matching contributions on Michelle’s behalf totaling $2,250 ($25,000 x 6% = $1,500 plus $25,000 x 3% = $750).
Under the plan’s terms, however, Michelle was entitled to a $3,000 match. This is because she deferred a total of $3,000 for the plan year ($2,250 plus $750). As a result, ABC needs to make an additional (“true-up”) matching contribution of $750 to Michelle’s account. This true-up contribution may be made as late as the deadline (including extensions) for filing ABC’s federal tax return. As a calendar-year employer, this deadline would be September 15, 2012.
If the required true-up contribution is not made by that date, the plan would have an operational failure. By calculating the matching contribution on a pay-period basis, rather than an annual basis, ABC would not be following the plan’s terms. Accordingly, assuming the other eligibility requirements are satisfied, ABC could use the IRS’s Self-Correction Program (“SCP”) to correct the mistake. (See our March 2012 article for a discussion of the various correction methods available to plan sponsors under the Employee Plans Compliance Resolution System.) Note that, under SCP, any true-up contribution would have to be increased to reflect lost earnings.
If your 401(k) plan document calls for an annual matching contribution, you should consider one of the following options:
- Waiting until year-end to make the matching contribution.
- Contributing each pay period, but then making a true-up contribution at year-end (if necessary).
- Amending the plan to provide for the calculation of matching contributions on a pay-period basis.
Finally, here are some suggestions for all 401(k) plan sponsors on how to avoid this common plan mistake:
- Review your plan document to determine the proper timing of matching contributions.
- Review the timing of the matching contributions that you are actually making.
- If your plan document calls for a match to be calculated on an annual basis, but you actually match on a pay-period basis, make a timely true-up contribution.
- Stay informed of any changes to your plan’s matching contribution formula.