(b)lines Ask the Experts – Enhanced Match for Longer-Term Employees

“This is our only employer contribution. We are considering enhancing our matching formula to reward longer-service employees (50% of the first 6% of an employee’s elective deferral for the first 10 years of service, and 100% of the first 6% after 10 years). Are there any drawbacks to this approach? We currently pass all nondiscrimination testing, including ACP testing, by a wide margin.”     

Michael A. Webb, vice president, Retirement Plan Services, Cammack LaRhette Consulting, answered:  

Yes.  The experts would suggest that this approach could result in additional compliance burdens (which may or may not be of concern to you). First of all, your ACP testing, which compares the average match for highly-compensated employees (defined in 2012 as those who earned in excess of $110,000 in 2011) to those of non-highly compensated employees (everyone else) will likely become more difficult to pass if a disproportionate amount of your longer-service employees are highly compensated (which is the case in many organizations).    

Plus, you will be adding a special nondiscrimination test to your menu of tests if you adopt this approach. There is a section of 401(a)(4) that addresses so-called “benefit, rights, and features testing”. Most of the tests under this section relate to specific plan features that have nothing to do with contribution amounts, but there is language that states that the right to a particular rate of matching contribution is a “right” that must be separately tested. Due to the testing methodology, which requires separate testing for each rate of matching contribution, it is particularly difficult to pass this test with a service-weighted formula if longer service employees are disproportionately highly compensated. And the correction method for addressing a test failure—retroactive plan amendment to the first day of the plan year in which the failure occurred to increase contributions to certain employees so that testing is passed—is cumbersome and expensive.   

For these reasons, it is rare to encounter 403(b) plans with a service-weighted matching contribution; generally if service is to be rewarded, it is generally accomplished with respect to non-matching (base or discretionary) employer contributions.    

It is also important for the experts to note that a service-weighted matching formula would be more viable in a 403(b) plan or a governmental entity or a church/QCCO under 3121(w), where the nondiscrimination rules cited above do not apply.