Automatic enrollments and PTO contributions

By josephstenken

Tax Facts | National Underwriter Company


In early September, President Obama gave a speech on how to improve retirement savings. In conjunction with that speech and as part of the Internal Revenue Services' Retirement and Savings Initiatives, three revenue rulings were issued to help sponsors enhance retirement plans, particularly regarding automatic enrollment and default investments.

In Revenue Ruling 2009-30, the Internal Revenue Service addressed two situations regarding how automatic increases to plan default deferral amounts may be implemented. First, the ruling addressed the issue of whether an automatic increase that is based, in part, upon an employee's increased compensation may be used in an automatic contribution arrangement (ACA) plan that is not intended to be an eligible automatic contribution arrangement (EACA) or qualified automatic contribution arrangement (QACA). The ruling contains an example that illustrates an increase in the ACA default percentage (for participating employees who fail to make an affirmative election) by the greater of 1 percent of an employee's base pay or 30 percent of the increase in base pay for the affected employee. In all cases, the participant would be offered the option to select a different deferral amount. The IRS determined that this type of arrangement is permitted if the plan is not intended to meet the requirements of an EACA or QACA. Conversely, if the plan is designed to satisfy the EACA or QACA provisions of the law, then the stated increase in the scenario would not meet the associated uniformity requirements applicable to an EACA or QACA qualifying plan.

The second scenario addressed under Revenue Ruling 2009-30 is regarding the question of whether an increase in the default percentage for an employee may be effective on a date other than the first day of the plan year. An example in the ruling has a calendar year plan where pay raises for employees are effective annually on April 1st. The plan, in turn, increases the default deferral percentage for employees (who have failed to make an affirmative election) on the first pay date after April 1st. The ruling provides that these default increases are allowed to be effective on a date other than the first day of the plan year and that this plan design will not violate the uniformity and minimum percentage requirements of EACAs and QACAs.

Revenue Ruling 2009-31 addresses the treatment of contributions to a plan of the dollar value of unused paid time off (PTO) remaining at the end of the year for active employees. If the employee does not have the right to elect to receive the amount as income, the dollar-equivalent of the unused PTO may be contributed to the plan by the employer as a non-elective contribution. If the employee is provided the option to receive the amount as a cash payment, and the amount is contributed to the plan, the contribution is an elective deferral. This is an optional plan provision and the plan must contain language to allow these types of contributions. In the elective deferral case, assuming the plan utilizes the option allowed in Section 415 regulations to recognize this type of pay as compensation, allowing this PTO contribution merely increases the percentage of this type of pay that may be deferred, assuming the plan limits deferrals to some smaller percentage as a general rule. This is similar to providing an election to defer an entire mid-year bonus.

The implications of this feature, however, should be considered carefully by plan sponsors before implementation. These contributions (in combination with other contributions made to the plan) are subject to nondiscrimination testing and annual limits. Because of the discrimination testing implications, a sponsor should review which employees tend to have unused PTO at the end of the year. If these employees are usually highly compensated employees, what appears at first blush to be an additional benefit under the plan may end up causing a testing problem. Limiting the benefit to non-highly compensated employees could be considered and would likely eliminate this potential problem.

Revenue Ruling 2009-31 also confirms that the amounts contributed to the plan as either a non-elective amount or an elective deferral amount would not be taxable to the participant until distributed from the plan, and that the arrangement would not cause the PTO pay itself to run afoul of the Section 409A (the nonqualified deferred compensation rules) exception for PTO.

Revenue Ruling 2009-32 addresses the issues described in Revenue Ruling 2009-31 in the context of the contribution to a retirement plan of the dollar equivalent of unused PTO for terminated employees and the taxation of these contributions. This ruling contrasts a situation where the termination occurs in the middle of the year with a situation where the termination occurs at the end of the year, with payment of the unused paid time off paid in the next year.

The key issue for the payment of end of employment contributions is the determination of the amount of unused PTO that may be deferred in the year following termination of employment under the Section 415 compensation-based limits. In the case of elective deferrals, compensation is the amount actually paid plus the amount of elective deferrals. In the case of non-elective contributions, compensation is simply the amount that is actually paid because there are no elective deferrals. For an individual who only has this compensation type during a particular year, all of the compensation may be deferred as an elective deferral, but only half may be contributed on a non-elective basis.

Rev. Rul. 2009-30, 2009-39 IRB ___; Rev. Rul. 2009-31, 2009-39 IRB ___; Rev. Rul. 2009-32, 2009-39 IRB ___.

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