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Misbehaving Savings – Part 5 of 5

By Jack Towarnicky

Responding to Intriguing Participant Requests
March 2006 – Second Class Compensation

During my three-plus decades in plan sponsor roles (1979-2010), I often studied workers’ savings elections and took the opportunity to frequently ask them to explain their contribution, investment and withdrawal decisions. I shared a few encounters – the first, second, third, and fourth – in previous blog posts.

In Feb. 1987, I insisted on changing the definition of covered compensation. In the past, we only considered base salary in calculating benefit accruals for our defined benefit pension plan and employer-matching contributions in our 401(k) savings plan. I highlighted to leadership that excluding incentives from covered compensation reduced the incentive to second-class status.

Fewer than 15 years later, my employer adopted a broad-based variable incentive compensation program that would apply to all workers. It was based on corporate, business unit and department results, sometimes combined with individual performance assessments, and was always calculated as a percentage of base pay. It was paid in the first biweekly paycheck in March of the subsequent year.

Not surprisingly, the IRS (and many states) have specific rules regarding income tax withholding for such “supplemental wages” per the Revenue Ruling 2008-29. My employer used the “optional flat-rate procedure” and assessed federal income tax withholding at 25 percent. Many were unhappy about the reduction in take-home pay from this withholding requirement. For those workers, that disappointment was compounded also by applying the 401(k) contribution election on the incentive compensation award.

Well, it only took a year or two before workers started to complain that they wanted to exclude the incentive compensation from the 401(k) contribution calculation. They wanted to take home more of the incentive award. I explained to some of those workers that the employee contribution percent is determined by taking the actual dollars contributed year to date and dividing it by the total covered compensation year-to-date. Then, the employer match was calculated as 50 percent of the employee-contribution percent, with a maximum of 3 percent. That company contribution percentage was then applied to covered compensation year-to-date to calculate the company contribution year-to-date, and trigger company contributions as necessary. This was considered a “best practice,” ensuring a biweekly true-up on company contributions. So, if a worker didn’t defer 6 percent of pay, including the incentive compensation, they would not get the full employer match.

When I resisted changing the plan provisions or administration, a human resources representative started to perennially circulate an email that confirmed the cut-off date for elections to reduce the contribution percentage for the first payday in March. That person was so proud of this alert that it was shared among the human resources community as a “best practice.” Sure enough, the corporate communication and compensation folks got into the act and made it a formal notification to all workers who would be receiving incentive compensation.

A number of workers reduced their contribution percentage – some to zero – in order to increase their take-home pay for the first pay period in March. Unfortunately, too many who made that election failed subsequently to increase their contribution percentage enough to qualify for the full employer match.

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