Administration Pitfall - Defining Compensation

This week’s common pitfall for discussion is the use of incorrect or inconsistent definitions of compensation when determining deferral amounts or other employer contributions. Believe it or not this is a very common mistake. 

Make sure you understand what compensation you should report to your TPA based on the definition of your plan document. It is also tricky to try to exclude compensation from the plan (like overtime or bonuses) as that requires additional testing. This is also something that should be dealt with at the time of plan set-up or review.

The correction method is that we would have either additional contributions due to participants or would need to reallocate or take away contributions from participants. Think about how much it could cost to make additional contributions to the plan especially if you have used the wrong compensation definition for several years.  Or what if you have to take away contributions made to participants and what if they have terminated and taken a distribution. These situations are very problematic and happen more regularly than you would think.

Make sure that the payroll company or other person providing the compensation information to the TPA knows what should be reported.   The TPA can help with those discussions and the verification that the correct compensation is being used.