Compensation is what we pay our employees, right?  Yes, to an extent if the compensation only includes wages, salaries, bonuses, overtime and commissions.  But what if there are other items that are taxable to the employee?

For example:
Assume you offer group-term life insurance and other taxable fringe benefits to your employees.  The value is included in the employee’s total compensation.  You have asked JM Pension to allocate 5% of compensation as profit sharing to eligible employees.  Is the taxable fringe benefits included when calculating the 5%?  Yes, unless you have selected 3401(a) withholding as your plan’s definition of compensation.

Confusing, right?  It doesn’t have to be, even though the IRS considers one of the most common mistakes in managing a retirement plan is allocating plan contributions to participants using incorrect compensation.  The easiest way to design the compensation definition is to start with the most inclusive (415 statutory) and then exclude what you don’t want.  Note that you can also determine which source of funds the exclusion will apply to (salary deferrals, matching, profit sharing, etc.).  The following lists some of the more common exclusions to compensation.  Note that some items, such as overtime pay, may need to be tested to prove the exclusion is not discriminatory in practice.

This list is not exhaustive.  You can include other adjustments if it is objectively determinable and not subject to Employer discretion.   Note that severance pay is not considered compensation for retirement plan purposes.  Why?  It is taxable so it should be included, right?  No – the employee did not perform any services for the additional compensation, so it is excluded.  Payment of unused PTO (sick leave, vacation leave) is not considered severance pay.

Now to add a wrinkle.  On an annual basis, JM Pension will ask you to provide census data so we can perform the annual administration of your plan.  Often, this includes allocating required or discretionary employer contributions. To perform certain tests, we need gross compensation.  Gross compensation will include not only pre-tax deferrals, but also any deduction on a pre-tax basis (including FICA and Medicare) for welfare premiums or Section 125 benefits.  But we’ll also need compensation as defined in your plan document.  The easiest thing to do?  Ask us for assistance in developing a specific census for you or simply send us a copy of your annual payroll register.  That will include all types of information about your components of pay, and we can determine what components we need.