Year-End Bonuses and Compensation (Defined Contribution Plans)

It’s that time of year when many companies will give year-end bonuses to employees. When running these through your payroll, be sure you know if you need to deduct employee deferral elections from the bonus. Your plan document will state whether or not bonuses are excluded from the definition of compensation and special rules for the treatment of deferrals on bonuses.

Compensation errors are common among retirement plans. In fact, it’s listed as one of the Top 10 errors found in audits. To ensure you are operating your plan in accordance with your plan document, you should take the following steps:

  1. Read your plan document. It seems simple, yet failure to read and understand how your plan defines the definition of compensation could cause expensive errors.
  2. Make sure your HR and payroll people know what compensation should and should not be included for contributions. This is especially important if you have a new plan, new HR representative, new payroll provider or a change has been made to your plan document.
  3. Do an internal audit. Review your payroll files to verify contributions are being calculated correctly. The earlier a mistake is caught, the easier and cheaper it is to fix.

Accuracy of the year-end compliance work is incredibly important. Since the testing may entail multiple definitions of compensation and complex testing procedures, it is essential to submit accurate census information since this could dramatically impact the test results. If your plan excludes bonuses, overtime, fringe benefits, etc. from compensation, make sure your payroll is deducting deferral contributions from the correct compensation. Additionally, make sure you are allocating employer contributions such as match or profit sharing on the correct compensation amount.

As the plan sponsor, you are responsible to ensure the plan is being administered according to the plan document provisions. Therefore, if your plan document doesn’t reflect how you are actually handling payroll, talk to your document provider to see if your plan can be changed.

If you have questions about your plan’s definition of compensation, please contact your Watkins Ross Retirement Plan Administrator.

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