Print Friendly Version Print Friendly Version

Using unused PTO as 401(k) plan contributions

“My client has unused PTO with his employer and participates in the company’s 401(k) plan. Is there any way he can use the equivalent dollar amount of unused PTO to increase his 401(k) contributions?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans, including nonqualified plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Pennsylvania is representative of a common inquiry related to paid time off (PTO)[1] and 401(k) plans.

[1] Generally refers to a sick and vacation arrangement that provides for paid leave whether the leave is due to illness or incapacity.

Highlights of Discussion

Yes, it is possible that the equivalent dollar amount of unused PTO can be contributed to the 401(k) plan, provided 1) the 401(k) and PTO governing plan documents contain provisions to accommodate such conversions and contributions; 2) the contributions do not unduly discriminate in favor of highly compensated employees; and 3) the contributions do not exceed mandatory contribution limits (see Revenue Rulings 2009-31 regarding the conversion of annual unused PTO and 2009-32 for the conversion of unused PTO upon termination of employment).

Revenue Ruling 2009-31 outlines two possible PTO conversion-to-contribution scenarios that could be applied on an annual basis: 1) where the value of any unused PTO that would otherwise be forfeited is instead converted and contributed to a 401(k)/profit sharing plan as an employer nonelective contribution; and 2) where the value of any unused PTO that would otherwise be paid out in cash to the employee is instead converted to a salary deferral to the 401(k) plan at the employee’s election.

Scenario 1

Company Z maintains a PTO plan and a 401(k) plan. Under Company Z’s PTO plan, no unused PTO as of 12/31 may be carried over to the following year. Company Z amends its 401(k) plan and PTO plan to provide that the dollar equivalent of

1) Any unused PTO of an employee as of the close of business on 12/31 is forfeited under Company Z’s PTO plan and the dollar equivalent of the amount forfeited is allocated to the participant’s account under Company Z’s 401(k) plan as of 12/31 as a nonelective contribution up to the applicable annual additions limitation under IRC § 415(c) (the “415 limit”), and

2) Any remaining unused PTO is paid to the employee by 02/28 of the following year.

Nondiscrimination testing under IRC §401(a)(4) based on the contributions made for individual participants, generally, will be required, because the amount contributed and allocated for each participant will vary based on the amount of each participant’s unused PTO.

Example:

Sam works for Company Z and earns $25 per hour. He also participates in Company Z’s 401(k) and PTO plans with provisions as described in Scenario 1. As of 12/31/17, Sam had 20 hours of unused PTO. Therefore, the dollar equivalent of Sam’s unused PTO is $500. Because of the 415 limit, Company Z may contribute only $400 of unused PTO to Sam’s account under the 401(k) plan as an employer nonelective contribution.

Consequently, Company Z contributes $400 to its 401(k) plan on behalf of Sam as a nonelective contribution on 02/28/18, and allocates this amount to Sam’s account under Company Z’s 401(k) plan as of 12/31/2017. Company Z pays Sam the remaining $100 in cash on 02/28/2018.

Scenario 2

Company A maintains a PTO plan and a 401(k) plan. Under A’s PTO plan, at the end of the year employees may carry over to the following year an amount of unused PTO that does not exceed a specified number of hours (the carryover limit). The dollar equivalent of any unused PTO for a year in excess of the carryover limit is paid to the participant by 02/28 of the following year. Company A amends its 401(k) and PTO plans to provide that a participant may, prior to receipt, elect to treat all or part of the dollar equivalent of any unused PTO as an employee salary deferral to the 401(k) plan and have it allocated to the participant’s account as of the beginning of the third pay period of the following year as long as the amount does not exceed the 415 limit nor IRC §402(g) limit [the “402(g) limit”]. The dollar equivalent of any unused PTO that is not deferred to Company A’s 401(k) plan is paid to the participant by 02/28 of the following year.

Scenario 2

Company A maintains a PTO plan and a 401(k) plan. Under A’s PTO plan, at the end of the year employees may carry over to the following year an amount of unused PTO that does not exceed a specified number of hours (the carryover limit). The dollar equivalent of any unused PTO for a year in excess of the carryover limit is paid to the participant by 02/28 of the following year. Company A amends its 401(k) and PTO plans to provide that a participant may, prior to receipt, elect to treat all or part of the dollar equivalent of any unused PTO as an employee salary deferral to the 401(k) plan and have it allocated to the participant’s account as of the beginning of the third pay period of the following year as long as the amount does not exceed the 415 limit nor IRC §402(g) limit [the “402(g) limit”]. The dollar equivalent of any unused PTO that is not deferred to Company A’s 401(k) plan is paid to the participant by 02/28 of the following year.

Example:

Barb works for Company A and participates in its PTO and 401(k) plans under the terms described in Scenario 2. As of the close of business on 12/31/17, Barb had 15 hours of unused PTO in excess of the carryover limit and earns $30 per hour, so the dollar equivalent of Barb’s unused PTO in excess of the carryover limit is $450. Before receipt of the amount, Barb elects to have 60% of the dollar equivalent of the unused PTO, or $270, contributed to Company A’s 401(k) plan as an employee salary deferral. The contribution does not cause Barb’s deferrals to exceed the 402(g) limit nor the 415 limit. Company A allocates $270 to Barb’s account under the 401(k) plan as of 02/01/18. Under the terms of Company A’s 401(k) plan, this amount is treated as a contribution for the 2018 plan year. Company A pays Barb the remaining $180 on 02/01/18.

Conclusion

As a way for companies to increase their employees’ ability to save for retirement, a number of plan sponsors have amended or are considering amending their 401(k) and PTO plans to allow the equivalent dollar amount of unused PTO time to be converted to 401(k) plan contributions. The terms of the plan documents will dictate the process and treatment of the contributed amounts. Plan sponsors can refer to Rev. Ruls. 2009-31 and 2009-32 for specific guidance.

© Copyright 2019 Retirement Learning Center, all rights reserved
0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *