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Different types of plans and different types of contributions within plans must meet a variety of different Internal Revenue Service (IRS) and Department of Labor (DOL) requirements. The following summary is designed to provide you with guidelines applicable to most 401(k)/profit sharing plans. For specific information regarding your plan, you should consult with The Paragon Alliance Group, LLC and/or your retirement plan document.
First, it is important to realize that 401(k) plans are profit sharing plans with the added feature of utilizing a 401(k) pre-tax and Roth salary deferral contribution provision. Often, a plan will provide for matching contributions to incent employees to defer from their pay toward retirement. Since they are profit sharing plans, these plans also may allow for discretionary profit sharing contributions. Other types of contributions may be required, depending on the specific plan.
401(k) pre-tax and Roth salary deferral contributions are funds withheld from each participating employee’s paycheck. Each employee, subject to overall plan and IRS limitations, determines the amount of these contributions. The employer is directed to withhold the designated amounts from the participant’s paycheck so that the participant may take advantage of the available tax savings at the point of payroll (pre-tax), or at retirement (Roth), as well as accumulating a “nest egg” for retirement. Each employee makes the decision to either receive the money in is his/her paycheck as part of compensation, or to have the money withheld and remitted to the retirement plan Trust for investment.
The DOL has strict regulations regarding the timeframe in which elective deferral contributions must be transferred by an Employer to a qualified plan.
Deposits must be made consistently each time deferrals are withheld and must be made as early as possible every time. While it is vital to submit deferrals quickly, it is important to note that the IRS and DOL also frown upon the practice of pre-funding prior to the date on which they would have otherwise been paid to the employee. It is not unusual for the DOL to take the position that the deferrals should be segregated within three to five days of being withheld on a consistent basis.
Since the annual IRS Form 5500 has a question that asks, “Did the employer fail to transmit to the plan any participant contributions to the plan within the regulated time period,” all Plan Sponsors must comply with this regulation. If not, it is our understanding that it may trigger a DOL audit as well as potential penalties and excise taxes.
Matching contributions may be made to 401(k) plans in a manner specified in the plan document. Matching contributions are company, or employer, contributions and provide employees a greater incentive to save, Strict 401(k) deposit timing rules do not apply to them. Matching contributions are typically made according to a formula, (e.g., the company will “match” 401(k) contributions at the rate of 50% on the first 6% contribution made by each employee). These contributions may have further conditions, such as requiring the employee to complete at least 1,000 hours of service during the year, and/or still be employed on the last day of the year.
When matching contributions should be deposited depends on these conditions. If the matching contribution is conditioned on being employed at the end of the plan year, then the matching contributions should not be made until after the end of the plan year when it can be properly determined who is entitled to receive them. Many plans, however, impose no conditions on matching contributions other than the employee being eligible for, and making, 401(k) contributions. In this case, matching contributions are calculated with each payroll and generally funded simultaneously with 401(k) contributions. Per payroll match allows the company to better manage cash flow while providing the employees more immediate satisfaction in seeing their matching contributions deposited along with their contributions. We feel that this is an important consideration, since a primary purpose of matching contributions is to encourage employees to make 401(k) contributions. Paragon will assist you in determining the Match formula that will optimize participant outcomes based on the company’s financial budget in order for the company to maximize the ROI.
In any event, the ultimate deadline for making matching contributions is the tax-filing deadline for the company’s tax return for the fiscal year in which the plan year ends, including extension.
Profit Sharing Contributions
Profit Sharing contributions may or may not be made in any given plan year; they are entirely at the discretion of the company. If contributions are made, they are typically allocated to eligible plan participants, regardless of whether they defer from their paycheck. The formula is typically based on their compensation, or a combination of their age and compensation. Like matching contributions, profit sharing contributions are in addition to employees’ regular compensation. To be entitled to receive a profit sharing contribution, plans frequently require employees to complete 1,000 hours of service AND be employed as of the end of the year. These contributions should generally not be made until after the close of the plan year when each employee’s eligibility, and the maximum allowable contribution, can be calculated. Estimates can be made immediately prior to the end of the year in conjunction with the company’s tax planning. The final contribution amount can be adjusted after the end of the year, if necessary.
As with matching contributions, profit sharing contributions must be made by the tax-filing deadline for the company’s tax return for the fiscal year in which the plan year ends, including extensions.
There are two other common types of contributions that may be made to a 401(k) plan, Qualified Non-Elective Contributions (QNECs) and Top-Heavy minimum contributions.
Qualified Non-Elective Contributions
QNECs, or what used to be known as “fail-safe” contributions, can be used as a means of correcting a failed ADP/ACP test. Briefly, salary deferral contributions must pass certain IRS tests. If they do not, the plan can refund contributions to “highly compensated” employees until the tests pass. Sometimes companies do not want to have their most valued employees take refunds, or it is simply more cost effective for the company to make an additional contribution to non-highly compensated employees to make the tests pass.
If your plan permits, QNECs are typically allocated to all non-highly compensated employees who participate in the plan. They may be allocated only to those employees who make their own 401(k) deferrals, or to all eligible employees. They may be allocated as a percentage of compensation, or as a flat dollar amount to each participant. QNEC contributions must be made within one year of the plan year-end for which they are to be applied. Also, QNEC’s are immediately vested. If the company wants to deduct them on its tax return applicable to the plan year for which they apply, then they should be contributed by the company’s tax return filing deadline, including extensions.
Top-Heavy Minimum Contributions
If 60% or more of the plan assets are held on behalf of “key” employees, the plan may be “top-heavy”. If so, and any “key” employee has contributions exceeding 3% of pay, each eligible “non-key” employee must receive a minimum contribution, typically 3% of compensation for the plan year. Their own 401(k) contributions do not count, but matching contributions do count in meeting this minimum. Frequently, however, this minimum contribution requirement is met as part of the profit sharing contribution. For more detailed information, please refer to “Top Heavy 401(k) Plans."