Retirement plan participants are allowed to make catch-up contributions, but a question that arises in plan administration is: When does an employee salary deferral count as a catch-up contribution? Read on for expert intel.
Understanding The Treasury Rules
Experts at The National Association of Plan Advisors explain that according to Treasury Regulation § 1.414(v)-1, a salary deferral made by an employee becomes a catch-up contribution “when it exceeds the lowest of the following three limits”:
A statutory or legal limit (as explained below);
A plan-imposed limit stated in the plan document; and
The plan’s actual deferral percentage (ADP) limit on salary deferrals.
Salary deferrals above the lowest of these three limits will be considered catch-up contributions up to the annual catch-up maximum amount for a 401(k) plan (i.e., $7,500 for 2023).
Examples of a statutory or legal limit include the IRC Sec. 402(g) limit (i.e., 22,500 for 2023) or the IRC Sec. 415(c) annual additions limit (i.e., 100% of a participant’s compensation up to $66,000 for 2023)….A plan limit would be if the plan document were to specify that employee salary deferrals are limited to 10% of a participant’s annual compensation….A plan’s ADP limit…is determined by comparing the salary deferrals of the highly compensated employees (HCEs) to those of the nonhighly compensated…and limiting deferrals for HCEs…to satisfy the ADP nondiscrimination test.
Experts observe that catch-up contributions can be complicated to administer and offer this bottom line reminder: “An employee salary deferral becomes a catch-up contribution when it exceeds the lowest of a legal limit, a plan-imposed limit or the ADP limit.” This example may also be instructive:
Rowan is a 55-year-old HCE who participates in a 401(k) plan he established for his firm. His compensation for the year is $100,000. The maximum IRC Sec. 402(g) limit for the year is $22,500. The terms of the 401(k) plan limit employee salary deferrals to 10% of compensation or, in Rowan’s case, $10,000. The plan administrator determines the salary deferral ADP limit for the year is $8,000. The lessor of $22,500, $10,000 or $8,000 is $8,000. Therefore, any salary deferral Rowan would make above $8,000 (up to a maximum catch-up limit of $7,500) would be considered a catch-up contribution.
A New Twist?
As the retirement industry has dug into the massive new SECURE 2.0 provisions, one of the most buzzed about technical errors in the legislation has been related to catch-up contributions. However, a Congressional letter has provided clarification, which Plan Sponsor has summarized:
Section 603…requires catch-up contributions made by highly-compensated employees to be made to a Roth account, starting in 2024. This section accidentally removed catch-ups entirely for everyone, Roth or not. As the letter explained, “Congress did not intend to disallow catch-up contributions … Congress’s intent was to require catch-up contributions for participants whose wages from the employer sponsoring the plan exceeded $145,000 for the preceding year to be made on a Roth basis and to permit other participants to make catch-up contributions on either a pre-tax or Roth basis.”
A Frequent Mistake
A common—and dangerous—oversight on the part of plan sponsors overall is the assumption that contracting with service providers eliminates the sponsor’s liability for errors, which is simply not true. Indeed, because sponsoring company benefit plans comes inherent with 3(16) fiduciary obligations, plan sponsors can be held personally liable for errors and this is a risk that can never be fully eliminated. Although it is true that “ERISA allows plan sponsors to outsource some of their 3(16) fiduciary responsibilities by formally appointing another entity to assume some of their plans’ administrative functions,” the plan sponsor always retains fiduciary responsibilities, such as the decisions made in the selection and monitoring of third party services providers. Experts also remind us “Not all fiduciary services are created equal. In today’s increasingly litigious environment, it is imperative for plan sponsors to be educated consumers of ERISA fiduciary services” and follow a prudent process for outsourcing 3(16) responsibilities.
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