One of the Top 10 Mistakes made by 401(k)/403(b) plan sponsors is failing to follow the definition of “compensation” under the terms of the relevant plan document. Compensation can be defined several different ways for plan administration purposes. For example, compensation may be defined as W-2 wages, which would include bonuses for purpose of making elective deferrals. Using the example, if an employer fails to allow the employer to defer off a year-end bonus (part of W-2 compensation), the plan has experienced an operational error, which affects its tax-qualified status.
We recommend that plan sponsors regularly confirm that the appropriate definition of compensation is being used for all plan operations (for match, profit-share, deferrals -- to name some of the problems we have had to correct for clients). Further, any employee and third-party administrator should ensure that the definition of compensation is used properly for all plan administrative functions, and, if errors occur, the employer must explore options on how to correct (to save the tax-qualification and to insulate against any fiduciary breach claims).