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Is Bonus Pay Subject To 401(k) Deferral Elections?

Depending on your 401k retirement plan document, bonus pay may be included in the definition of compensation upon which you may defer. Knowing if your plan considers bonus pay will help you determine the annual deferral amount you want to contribute to the plan when saving for retirement.

Does Our Plan Consider Bonus Pay?

The quickest way to determine if any compensation is excluded is to review your Summary Plan Description (SPD). The SPD is the participants version of the plan document. Within the SPD will be a section indicating what compensation is includable in the plan. In general most 401(k) plans define compensation utilizing compensation reported on Form W-2 and since bonus pay is included on a W-2 it will be considered for plan purposes. If bonus pay is excluded from the definition of compensation it should be specifically mentioned in the SPD.

Participant Elections

Your plan can allow for the following participant elections:

  • Flat dollar amount, or
  • Percentage of compensation, or
  • Both - either a flat dollar amount or a percentage of compensation

If my friend Parker has elected a flat dollar amount of $50 to be withheld each pay period and a bonus is included in that pay period, Parker will have $50 withheld. Where we see a potential issue for Parker is if they decide to withhold a percentage of compensation. 

Percentage of Compensation a Potential Issue 

  • Parker earns $3,750 gross per pay, paid semi-monthly, which totals to $90,000 per year.
  • They have elected 7% be withheld pre-tax each pay period.
  • The plan allows for deferral changes at any time, so Parker could inform HR they want more or less withheld on future payrolls. We'll see how this could be beneficial to Parker later but for now, For this example we'll assume Parker keeps 7% all year long. 
  • Parker's pay does not change from January to December, except for an increase in August for a performance bonus of $2,000. 
  • The plan considers bonuses as plan compensation.

HR applies the 7% to Parker's gross pre-tax earning each pay period. Unfortunately, HR assumes the bonus Parker earned is not considered. Parker's total deferrals for the year total $6,300 (7% of gross pay). This would be incorrect based on the plan definition of compensation. Parker should have $6,440 withheld. See the chart below.

Payroll Date  Gross Compensation    7% Pre-Tax Deferral Election 
1/15/2021  $                      3,750.00  $                                       262.50
1/31/2021  $                      3,750.00  $                                       262.50
2/15/2021  $                      3,750.00  $                                       262.50
2/28/2021  $                      3,750.00  $                                       262.50
3/15/2021  $                      3,750.00  $                                       262.50
3/31/2021  $                      3,750.00  $                                       262.50
4/15/2021  $                      3,750.00  $                                       262.50
4/30/2021  $                      3,750.00  $                                       262.50
5/15/2021  $                      3,750.00  $                                       262.50
5/31/2021  $                      3,750.00  $                                       262.50
6/15/2021  $                      3,750.00  $                                       262.50
6/30/2021  $                      3,750.00  $                                       262.50
7/15/2021  $                      3,750.00  $                                       262.50
7/31/2021  $                      3,750.00  $                                       262.50
8/15/2021  $                      3,750.00  $                                       262.50
8/15/2021 - BONUS  $                      2,000.00  $                                       140.00
8/31/2021  $                      3,750.00  $                                       262.50
9/15/2021  $                      3,750.00  $                                       262.50
9/30/2021  $                      3,750.00  $                                       262.50
10/15/2021  $                      3,750.00  $                                       262.50
10/31/2021  $                      3,750.00  $                                       262.50
11/15/2021  $                      3,750.00  $                                       262.50
11/30/2021  $                      3,750.00  $                                       262.50
12/15/2021  $                      3,750.00  $                                       262.50
12/31/2021  $                      3,750.00  $                                       262.50
   $                    92,000.00  $                                   6,440.00

Timing 

As mentioned above, depending upon the provisions in your retirement plan participants could modify their elections quarterly, monthly, or at their discretion. Parker could have elected to have 50% of the bonus pay check withheld and then reverted back to a 7% election and the total withholdings for 2021 would be $8,912.50, nearly $2,500 more contributed toward retirement.

Best Practices for HR

A few practices which may be helpful when considering bonus pay:

  1. Always confer with your TPA and the plan document to ensure participant elections are applied to the correct compensation. 
  2. If bonuses are included in the definition of compensation then participant election percentages are applied to the bonus pay. The participant may inform you of a change to their election percentage for the bonus pay.
  3. Document and retain all changes to deferral elections, such as those requested via email or a signed election change form.

Additional Support

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