Required matching contributions (generally safe harbor) may be allocated in one of two ways: on a payroll period or an annual basis. The allocation method is stated in the Adoption Agreement (“AA”), and it determines how the match contributions are calculated and when they are deposited.
Payroll Period Basis Calculation:
With a pay period match, the match formula is applied to your participants’ deferrals and compensation amounts for each pay period. The activity in one pay period does not impact the calculation in other pay periods. Suppose, for example, a participant, Jane Smith earns $120,000 ($10,000 per month), and her plan gives her a match of up to 6% of compensation. For purposes of this example, Jane defers 12% of her salary for the first half of the year and 0% for the last half, and she gets paid once per month. With a pay period match, Jane’s employer match will only be up to 6% of her compensation for each payroll period that she defers (6% of $10,000 = $600 per month) so that extra 6% that she deferred for the first half of the year will not count towards any match. Since Jane is not deferring at all for the second half of the year, she will not receive any match for those monthly pay periods. Thus, Jane receives a total match contribution of $3,600 for the year.
Annual Basis Calculation:
An annual basis calculation determines the match based on the deferral rate for the entire plan year. Look what happens when we calculate Jane’s employer match on an annual basis. Jane is entitled to 6% of $120,000, or up to $7,200 for her match. She already received $3,600 for the first half of the year, and now she is owed an additional $3,600. As this example illustrates, true-up match contributions will generally provide a larger match contribution to participants who changed their deferral throughout the year.
It is important to keep in mind that the match on an annual determination can be funded at any cadence the sponsor desires. It could be funded each payroll period but Vestwell will calculate it based on annualized data.
Due Dates for Deposit
Match contributions with a pay period allocation method are required to be deposited no later than the quarter following the quarter in which the pay date falls. If they are not deposited timely, lost gains should be calculated to make up for any investment losses due to the delay. Match contributions with an annual allocation method have a more flexible deposit deadline; they do not need to be deposited until the business taxes are filed to be deductible for the plan year in question. For compliance purposes, they can be deposited after this up until 12/31 of the following year, but may not be tax deductible at that point. Please consult with their tax advisor to confirm.
True-up Contributions
Sponsors who choose to have an annual allocation method will be provided with a true-up report each year showing the amount of contributions that need to be deposited to meet the plan document requirements.
Sponsors that choose to have a payroll period allocation method are not necessarily required to make a true-up contribution at year-end; however, they are responsible for calculating and depositing the match per the plan document specifications. Vestwell may provide an informational year-end comparison report as part of the compliance package, which is intended to highlight significant over or underfunding of the pay period match contributions. Ultimately, it is the sponsor’s responsibility to ensure the match contributions are calculated correctly and deposited timely.
Which allocation method is the right one for my plan?
Each allocation method has its advantages and disadvantages. For example, a payroll period match will generally not create an unexpected expense at year-end, but the calculation does require additional administrative oversight for the sponsor to ensure they are matching properly each pay period. The annual determination period requires less work on the part of the sponsor, but may result in unexpected expenses at year-end if the match was not funded fully based on annual data. Each sponsor is different and should consider the administrative, financial, and operational pros and cons of the allocation methods to determine which is the best method for them.
Unsure which allocation method your plan has?
Your plan Adoption Agreement (“AA”) will tell you which allocation method you have; you can find your AA by logging into the sponsor portal and clicking My Plan > Plan Documents > Adoption Agreement. Once you have the AA in front of you go to section D.11 to see which allocation method has been selected.
Is there a better allocation method for your plan?
If you feel that a different allocation method would be better for your plan, let us know! We will confirm when the change can take effect and answer any other questions you have.