415 Compensation for Safe Harbor 401(k) Plans
Understanding 415 Safe Harbor compensation is crucial when setting up a retirement plan.
Employers have the option of defining what types of employee pay is eligible for employee 401(k) deferrals and company contributions when designing their plan. While most companies stick with a simple definition of compensation, some employers choose to exclude things like bonuses, commissions, etc. However, choosing to exclude compensation can make year-end compliance tests more difficult.
Safe Harbor 401(k) plans are designed to simplify compliance testing by meeting certain requirements. If an employer adopts the standard definition of compensation that includes all earnings in IRC Section 415(c)(3) then it can avoid certain nondiscrimination tests.
In this guide, we'll explain 415 Safe Harbor compensation, its use, and factors to consider when determining employee compensation. Let's dive in!
What is 415 Safe Harbor Compensation?
415 Safe Harbor compensation includes the employee's total taxable pay. This includes salary deferrals, fees for services, commissions and taxable fringe benefits. 415 compensation is not used for taxes, but is important for 401(k)'s to avoid additional 414(s) compliance tests. Code §415 allows for three variations that automatically pass the 414(s) rules:
- Statutory 415 compensation: generally includes all compensation in taxable income including salaries, commissions, bonuses, overtime and taxable fringe benefits or taxable reimbursements.
- Simplified IRC Section 415 compensation: can exclude compensation typically paid to highly compensated employees (HCEs) like taxable moving expense reimbursements and non-qualified deferred compensation.
- IRC Section 3401(a) wages - includes earnings that are subject to Federal tax withholding.
The Importance of 415 Safe Harbor Compensation
Safe Harbor 401(k) plans are designed to automatically pass certain compliance tests, such as the nondiscrimination testing. However, these plans still must pass the top-heavy test. In such cases, 415 Safe Harbor compensation becomes essential in verifying exemptions from nondiscrimination testing, determining key employee status, and calculating any required top-heavy contributions.
What to Include in 415 Safe Harbor Compensation
When determining the 415 Safe Harbor compensation for your employees, it's crucial to include various elements to ensure accuracy and compliance. Common items include:
- All wages: This includes regular wages, salaries, and any additional compensation received. Basically W-2 income.
- Professional service fees: Fees paid for professional services rendered by employees.
- Sales commissions: Any commissions earned by employees based on sales performance.
- Bonuses: Additional compensation provided as a reward for outstanding performance or achievements.
- Tips: If applicable, include tips received by employees as part of their compensation.
- Overtime: Compensation for any hours worked beyond regular working hours.
- Taxable fringe benefits or expense allowances: Include any premiums the company pays that would be treated as taxable income, such as voluntary life premiums. This would also include taxable expense allowances (like a cell-phone reimbursement).
- Foreign income: Taxable compensation received by employees for work performed outside their home country.
- Final pay (non-severance): Compensation provided to employees upon termination of employment, that would be taxable W-2 income (accumulated vacation, unpaid commissions etc.) that was accrued while working. This does not include severance packages.
What to Exclude from 415 Safe Harbor Compensation
Some things should be included in 415 Safe Harbor compensation, but there are also things that should be left out. Below are items that may be excluded:
- Employee compensation paid prior to entering the plan: Compensation received by employees before they became participants in the retirement plan.
- Employee receipts from an unfunded or unqualified plan: Compensation received by employees from plans that are not funded or qualified.
- Money received from health or accident insurance plans, already accounted for in another part of the tax code.
- Employee moving expenses: Expenses incurred by employees when relocating for work purposes.
- Benefits for medical or disability purposes, already covered in another part of the tax code, received by employees.
- The value of non-qualified stock options: Compensation received by employees in the form of non-qualified stock options.
- Group term life insurance over $50,000: Employees receive compensation in the form of group term life insurance valued over $50,000.
- Severance package is extra compensation for employees, separate from severance pay they receive.
Complying with IRS and ERISA regulations
Properly calculating and recording compensation is crucial to prevent costly corrections later on. Having a trustworthy 401(k) plan administrator is important. They can help you follow the rules of the Employee Retirement Income Security Act (ERISA) and IRS.
A good 401(k) plan administrator will be indispensable in helping you complete the required forms. They will also ensure that all information is accurate from the beginning. This proactive approach can save you time, money, and headaches down the line.
Conclusion
Understanding 415 Safe Harbor compensation is vital for small businesses looking to offer retirement plans to their employees. To follow IRS rules and avoid problems with nondiscrimination testing, include the right parts and leave out certain items.
To understand 415 Safe Harbor compensation and provide your employees with a secure retirement plan, seek assistance from a plan administrator. Start offering a retirement plan for your employees and learn about the benefits of 415 Safe Harbor compensation now!
