In Employee Plans News (Issue 2012-3, Nov. 14, 2012), the Internal Revenue Service (“IRS”) provides guidance, which indicates that a 401(k) plan’s matching contribution formula may require additional employer contributions at year’s end.
The guidance posits the following question: Our 401(k) plan’s match formula is 100% of a participant’s salary deferrals up to 3% of the participant’s entire year compensation with the matching contributions being made at the end of each payroll period. If a participant stops making salary deferrals mid-year, would we have to make additional matching contributions for that participant?
The IRS answers: Yes. If you haven’t made the amount of matching contributions required by the plan’s match formula when the participant stops making salary deferrals, you’ll have to “true-up” the matching contributions for the participant.
Many plans require the employer to match salary deferrals up to a percentage of a participant’s total compensation for the plan year (up to $250,000 for 2012). So, if a participant stops or decreases their salary deferrals during the year, you may
owe the participant an additional match.
An example: Steve elects to contribute 5% of his $48,000 annual compensation to his 401(k) plan. Steve’s employer pays him $2,000 twice a month, deducts $100 (5% x $2,000) from his salary and contributes it to his 401(k) account. Steve’s employer contributes a matching contribution of 100% of his salary deferral up to 3% of his wages every pay period, or $60 (3% x $2,000). The 401(k) plan document requires Steve’s employer to use his entire plan-year compensation to determine the amount of the matching contribution. Steve stops making salary deferrals in May. At that point, the total match for the year is $480 ($60 times 8 payroll periods).
In this case, the 401(k) plan requires Steve’s employer to make matching contributions of 100% of Steve’s salary deferrals up to 3% of his annual compensation (3% x $48,000). Even though Steve’s actual salary deferrals ($800) equaled only 1.6% of his annual compensation, his employer stopped matching when Steve stopped contributing in May. Steve’s employer must make an additional $320 ($800 – $480) in matching contributions to equal 100% of Steve’s salary deferrals up to 3% of his annual compensation required by the plan document.