Tracking Compensation and Getting It Right
Why Accurate Compensation Matters
Using incorrect compensation in retirement plans is a common mistake that can lead to calculation errors, failed testing, and noncompliance. These issues disrupt contributions and tax benefits, posing risks for both employers and employees. Ensuring the plan's compensation definition matches payroll data is essential for smooth operations.
Common Compensation Definitions
Different plans use varying definitions of compensation, each requiring careful tracking. Key definitions include:
- Total Compensation (Code 415): All earnings for the year, also called gross compensation.
- Withholding Wages (Code 3401): Wages subject to federal income tax withholding.
- W-2 Wages (Box 1): Withholding wages plus other reportable payments.
Withholding and W-2 wages are often used since they’re easier to obtain, though adjustments may be needed.
Adjustments and Exclusions
Plans may require adding back pre-tax deferrals, cafeteria plan premiums, or transportation benefits. Some income types can also be excluded if documented in the plan, including:
- Reimbursements or expense allowances
- Fringe benefits (cash/noncash)
- Moving expenses and deferred compensation
- Pay before eligibility or for Highly Compensated Employees (HCEs)
Exclusions must not favor HCEs, and annual nondiscrimination testing is required. Plans failing these tests must adjust contributions.
Compensation for Self-Employed Individuals
Self-employed individuals, such as partners and sole proprietors, rely on earned income from tax forms like Schedule C or K-1. Special adjustments apply to these earnings since they aren’t reported on W-2s.
Ensure Compliance and Accuracy
Accurate compensation tracking is challenging but critical for retirement plan management. Employers must align payroll systems with plan documents, monitor annual testing, and make necessary adjustments to remain compliant.
Seeking expert guidance ensures compliance and avoids costly mistakes, helping administrators stay on track.
