Do you know what your 401(k) Plan's Compensation Definition is?

Posted on Jul 5, 2022

Employees’ compensation is one of the most important items that a Third Party Administrator asks for on their yearly census. Plan documents include a legally compliant definition of “compensation.” Compensation is a huge component in determining 401(k) deferrals; match amounts; and profit-sharing calculations. It is also used for testing and determining HCE (highly compensated employees) and Key employees.

Generally, all compensation is considered for plan purposes. A plan sponsor can choose to exclude a variety of compensation; however, exclusions must be non-discriminatory and cannot impact only non-owners of non-highly compensated employees. Examples of compensation that may be excluded in your legal plan document’s definition of compensation are:

• Compensation prior to plan entry
• Fringe benefits
• Expense allowances
• Overtime
• Bonuses
• Commissions

If your plan document’s definition of compensation is W-2 wages (compensation reported in Box 1 of the Form W-2), you add the participant’s salary deferral election and any pre-tax election under the plan sponsor’s cafeteria plan to that amount. Compensation paid after severance of employment is often included. These are checks paid to cash out unused vacation or final payroll that are issued after the termination date but paid within 2 ½ months of that date.