Payroll in Practice 10.18.2021

Question: Do defined benefit plans have annual contribution limits like defined contribution plans?

Answer: There are limits, but it can be difficult to say what they are because they are not fixed. Defined benefit plans are usually funded by employer contributions. However. some plans may allow or even require employee contributions. Rather than fixed amounts, the annual limits to plan contributions are based on the amount of the expected annual benefit and computations based on actuarial assumptions.

A defined benefit plan provides a specific benefit to the participant when the participant retires and starts receiving distributions. This might be a specifically defined amount for each period, such as a month or year, or a percentage of specified compensation paid during employment. The benefit amount for a particular employee is usually based on factors such as the employee’s earnings, age, and years of service. Employer contributions are not taxable to the employee when made.

Contributions to a defined benefit plan are based on the amount of funding required to provide the determinable benefits to plan participants. Actuarial assumptions and computations are used to estimate the contributions required to provide the specified benefits. Each year, an actuarial projection is made of the estimated future benefits that will be paid from the plan. That projection determines the amount, if any, that must be contributed to the plan that year to fund the projected benefit payments.

Rules related to the forfeiture of unvested benefits reflect the focus on computation and funding of projected employee benefits. If a plan participant leaves employment before the employer contributions for that participant become fully vested, any benefits that are not vested are forfeited by the employee.

For a defined benefit plan, forfeitures may not be used to increase the benefits that other employees would otherwise receive under the plan. Forfeitures must be used to reduce employer contributions. In contrast, forfeitures in defined contribution plans may either be allocated to the accounts of remaining participants in a nondiscriminatory way or be used to reduce employer contributions.

Annual contributions for an employee are limited to the amount needed to provide the projected future annual benefit for that employee. In general, the annual benefit for a participant under a defined benefit plan cannot exceed the lesser of: (1) 100% of the participant’s average compensation for their highest-earning three consecutive calendar years, or (2) $230,000 for 2021 and 2020. The dollar amounts are subject to cost-of-living adjustments in future years.

Additional information regarding defined benefit plans may be found in IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE and Qualified Plans). The IRS website covering defined benefit plan limits may also provide some insight.

Question: Our company uses a biweekly pay period for salary payments, but commissions are paid monthly, one month in arrears. For overtime computations, should the commissions be added to the regular rate of pay for the month in which the commissions are paid or the previous month when the commissions were earned?

Answer: The commissions should be allocated to the workweeks in which the commissions were earned. They should also be added to the regular pay for the appropriate workweeks in order to compute the overtime premium due on the commissions.

For example, Tracy’s biweekly salary is $1,200, based on a fixed workweek of 40 hours. The regular rate of pay is $15 per hour. Tracy should be paid $22.50 for any overtime hours worked during a workweek, as that is one-and-a-half times the $15 regular hourly rate of pay.

In Tracy’s case, the workweeks follow the traditional calendar weeks. Each workweek begins at 12:00 a.m. Sunday.

July 2021 began with a partial workweek, July 1 through July 3, followed by four full workweeks. Tracy worked no overtime during the workweeks ending July 3, July 17, and July 31. So, no overtime pay is due on commissions attributable to those weeks.

Tracy worked 46 hours during the July 10 workweek and was paid $690 straight time and $45 overtime premium. Tracy worked 49 hours during the July 24 workweek and was paid $735 straight time and $67.50 overtime premium.

On Aug. 31, Tracy was paid $6,000 in commissions for sales made in July. Of that, $2,500 was allocated to sales for the three nonovertime workweeks, $1,600 was attributable to the July 10 workweek, and $1,900 for the July 24 workweek.

Tracy’s regular hourly rate of pay for the July 10 workweek increased from $15.00 to $49.78, an increase of $34.78 due to the bonus ($1,600 / 46 hours). Tracy is due an additional $104.34 overtime premium ($34.78 x 0.5 x 6 hours) for that workweek. The total pay for the workweek is $2,439.34. The total regular pay for the week is $2,290 ($690 + $1600), and the overtime premium is $149.34 (49.78 x 0.5 x 6 hours) for a total of $2,439.34.

Similarly, the regular rate of pay for the July 24 workweek increased from $38.78 ($1,900 / 49 hours) to $53.78, and Tracy is due an additional $174.51 ($38.78 x 0.5 x 9 hours) overtime premium for that workweek.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, N.C., and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.