Contributing Vacation Time to 401(k) Plans: New Idea, Hidden Complexity
The IRS recently issued a ruling that allows 401(k) plans to be amended to accept contributions equal to the dollar value of unused vacation or other paid time off as either automatic (non-elective) contributions, or as elective contributions if the employee has the option of receiving cash. (PDF)
This option may be attractive to plan sponsors who don’t provide for or who limit the carryover of unused time off. However, the catch is that special monitoring will be required to make sure that the contributions do not exceed IRS limits.
The traps for the unwary are as follows:
- Section 415 limits: Total contributions to a 401(k) plan in any year may not exceed the lesser of a dollar amount (currently $49,000) or 100% of Section 415 compensation. Non-elective plan contributions are not treated as compensation, and particularly in the case of employees who have terminated employment, contributions in a later year may run up against the compensation limit.
- Maximum Elective Deferrals: Pre-tax contributions for a participant under all plans of all employers may not exceed the dollar limit in effect for the calendar year (the limit for employees under age 50 is currently $16,500) and must be made from Section 415 compensation.
- Non-Discrimination Testing: Because contributions of unused time will be variable, plans should evaluate their potential impact on any required non-discrimination testing.
Plan sponsors considering whether to add this feature to their plans need to factor these possible additional compliance tasks and costs into their decision.
