Keeping Matching Contributions

Keeping Matching Contributions “True”
By: Lynda J. Morrison
www.cbginc.com

We often use these articles to illustrate areas in which we see repeated confusion and/or errors. One such area involves the calculation of matching contributions. Many companies make matching contributions on a monthly or per payroll basis. However, many are not aware that the plan document will state whether the matching contribution is calculated on a payroll, monthly or annual basis, regardless of how frequently it is funded.

Assume that the terms of the plan document provide a matching contribution equal to 50% of 401(k) deferrals which do not exceed 6% of participants’ compensation. Further, the plan provides that the matching contribution is to be calculated on an annual basis.

Consider a participant earning $120,000 per year who deferred 20% to the 401(k) from January 1, 2003 through June 30, 2003, at which point his contributions equal the maximum permitted, $12,000 in 2003.

The company, on a monthly basis, makes a matching contribution equal to 50% of the amount participants deferred which did not exceed 6% of compensation. From January through June, the participant’s deferrals were $2,000 per month (20% of $10,000) and his matching contribution was $300 per month (the maximum 50% of $600 (6% of compensation). From July through December, the participant made no 401(k) contributions and received no matching contributions.

If no further adjustments are made, the Plan is not being operated in accordance with its terms. Under the terms of the Plan, the participant’s matching contribution is 50% of 401(k) deferrals which are not in excess of 6% of compensation, calculated on an annual basis. The impact to the participant is significant. For the plan year, the participant made 401(k) contributions of $12,000, received matching contributions of $1,800 and earned compensation of $120,000. Based upon the formula set forth in the plan, the participant’s matching contribution should have been 50% of $7,200 (6% of compensation), or $3,600.

The administrative solution to this problem is what is commonly referred to as a “true-up” calculation. At year-end, the match is recalculated on an annual basis and a contribution is made to “true-up” participants whose contributions are less than those calculated on an annual basis. Every plan which provides an annually calculated match which is funded more-frequently should perform a true-up calculation. Failure to perform the true-up calculation could result in a violation of the plan’s terms, a defect which jeopardizes the plan’s tax-qualified status.

Rather than performing a true-up calculation, the plan could be amended to provide that the match is to be calculated on a periodic basis, in this case monthly. This would avoid the need for a true-up calculation. However, it may adversely effect participants who “bunch” their 401(k) contributions early or late in the year (these are often highly paid employees and/or owners). If the match was calculated on a periodic (say monthly) basis, the participant discussed above, for example, would be well advised to spread his 401(k) contributions evenly over all 12-months.