Question:
We currently include bonus income in our 401k contributions and match but are considering stopping this. We have employees who get big bonuses and don’t want their 401k taken out, so I’m writing a separate check for them so it won’t come out. I would like to just stop that and not include that pay in the contributions. Do you know of any reason that we can’t do this?
Answer:
There are a few important considerations regarding excluding bonus income from 401(k) contributions and matching.
The first step is to carefully review your current 401(k) plan document. Most plan documents define compensation for 401(k) purposes as amounts reportable on Form W-2, which typically includes bonuses. If your plan currently includes bonuses in the definition of compensation, you would need to amend the plan document to exclude them.
While it is generally possible to exclude certain forms of compensation like bonuses, there are some potential issues to be aware of:
- Nondiscrimination Testing: Excluding bonuses could make it more difficult to pass nondiscrimination tests, especially if highly compensated employees receive larger bonuses. This could potentially disqualify the plan.
- Safe Harbor Plans: If you have a safe harbor 401(k) plan, compensation used must meet IRS 414(s) requirements, which limits exclusions.
- Employee Perception: Some employees may view the exclusion of bonuses negatively, especially if they were counting on making 401(k) contributions from their bonus income.
- Complexity: Having different compensation definitions for different purposes can increase administrative complexity and the potential for errors.
Instead of completely excluding bonuses, you could consider:
- Separate Elections: Allow employees to make separate deferral elections for regular pay and bonus pay5. This gives employees more flexibility.
- Opt-Out Option: Provide an option for employees to opt-out of 401(k) contributions specifically for bonus payments.
- Capped Contributions: Set a maximum percentage or dollar amount that can be contributed from bonus income.
If you decide to proceed with excluding bonuses:
Work with your 401(k) provider or an ERISA attorney to properly amend the plan document.
- Clearly communicate any changes to all employees.
- Ensure your payroll system is updated to reflect the new compensation definition.
- Be prepared for potential impacts on nondiscrimination testing.
I hope this helps.
Note: This blog post is for informational purposes only and should not be construed as legal advice. Always consult with a legal professional for advice specific to your situation.
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