(b)lines Ask the Experts – Using Base Pay to Calculate Deferrals

“We have done this for consistency purposes; it is easier for us, as well as the participants, to determine that the amount of match is correct if it precisely matches the rate of elective deferral, up to our maximum match. However, both of these definitions have always utilized “base” salary only, and have always excluded items such as overtime, bonuses, etc. We have always passed the required nondiscrimination testing under 1.414(s), so our compensation definition does not discriminate in favor of HCEs.   

“However, I have been informed by our vendor that our compensation definition for calculation of elective deferrals may no longer be permissible under the final 403(b) regulations. Is this true? I am hoping that this is not the case, since using total compensation for the elective deferrals and base pay for the match would thoroughly confuse some participants, and using total compensation for matching contributions is not feasible from a budget perspective.” 

Michael A. Webb, vice president of the Retirement Practice at Cammack LaRhette Consulting, answers:

It may very well be that you can retain your current definitions of compensation, but your provider was correct to caution you regarding the use of “base” pay in calculating the amount of elective deferrals, even if the definition is nondiscriminatory. The reason for such caution is that, as indicated in a recent Ask the Experts Q&A (see “Ask the Experts: Universal Availabilityand Excluding Compensation”) there may be an issue with providing an “effective opportunity” for certain participants to participate in the plan under the universal availability provision of the final 403(b) regulations.

As you can see from the regulatory language cited in that Q&A, denying a participant an opportunity to defer the maximum amount permitted under 402(g)/415 MAY be viewed as improperly excluding the participant from the right to make elective deferrals. For example, let’s say, you have otherwise eligible participant In the plan who do not have a base salary, but instead are paid on a “per diem” basis, and such “per diem” pay is excluded from your plan’s definition of compensation for elective deferral purposes. Thus, such employees would not be permitted to defer to the 403(b) at all, and it is possible that the IRS would consider such a restriction to be a violation of the universal availability provision.

We say “it is possible” since there is no clear guidance in the regulations. As stated in the prior Q&A, the issue may also exist where only a minimal amount of total compensation is paid as base salary, which may also deny a participant an “effective opportunity” to make elective deferrals to the plan.

These situations may not exist in your plan. For example you might provide all employees with a base salary that is sufficient to defer up to the 402(g)/415 limits. In that case, there should not be an issue. But if any of the aforementioned situations apply to your plan, you may wish to consult with benefits counsel well versed in such issues to determine if you are providing all employees with an “effective opportunity” to make elective deferrals to the plan in the absence of specific IRS guidance in this area.