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Compensation Definition In 401(K) Plans

Michael Johnson

Oct 27 2020

2 min read

When we hear the word “compensation,” many of us think about the dollars that are reported as gross pay on our check stubs. In retirement planning, the definition of compensation isn’t so cut and dry. There are multiple definitions of compensation, and depending on the definition your plan uses, compensation in your plan may appear quite different than that of another company.

THERE ARE FOUR DEFINITIONS OF COMPENSATION THAT CAN BE USED IN A PLAN.

415 compensation refers to IRS code section 415, which defines the components of this compensation. It is often referred to as “gross compensation” because it includes almost all types of pay (however, it does exclude severance pay, workers’ compensation, non-taxable fringe benefits and expense reimbursements).
414(s) compensation also refers to an IRS code section that outlines the components of this compensation. It is otherwise known as “nondiscrimination compensation,” as it is used for all plan nondiscrimination testing.
W-2 compensation can be used as the definition when the other types of compensation are not required. Compensation can be modified by excluding overtime and bonuses, excluding compensation prior to an employee meeting plan eligibility requirements or limiting compensation to a certain dollar amount.

COVID-19 compensation is pay associated with sick leave for family and medical leave under the Families First Coronavirus Response Act (FFCRA). This is included in your plan compensation unless specifically excluded in your plan document. It is typically treated the same as any other paid leave.

Compensation must be carefully considered in all aspects of retirement plan design. Regulations governing compensation are complex, but it is important to know what definition is used for specific aspects of the plan. There are times when the appropriate use of compensation can provide a greater benefit to owners and highly compensated employees.

Compensation means different things depending on the plan provision or law being interpreted. Sikich Retirement Plan Services can help you determine the appropriate compensation definition when designing a retirement plan based on your organization’s goals.

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About the Author

Michael Johnson

Michael Johnson, CPA, Director of Sikich’s Retirement Plan Services team, has expertise that includes retirement plan compliance, third party administration, and plan design and implementation. He has been a retirement plan consultant assisting clients in evaluating and administering their plans since 1987.