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Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants 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 and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Nebraska is representative of a common question on contributing unused Paid Time Off (PTO) to a 401(k) plan.
“Can a participant contribute their unused PTO to a 401(k) plan?”
As with most questions relating to 401(k) plans, the first part of the answer to this question depends on what the 401(k) plan document says, and the second part is what the PTO policy allows. If both the plan document and PTO policy allow the conversion of unused PTO to a 401(k) plan contribution, then the dollar value of the unused time may be contributed to the plan as long as the contribution does not unduly discriminate in favor of highly compensated employees (HCEs) and it does not exceed the contribution limits set by the IRS.
The IRS approved of this process in Revenue Ruling 2009-31 (conversion of annual unused PTO) and Revenue Ruling 2009-32 (conversion of unused PTO upon termination of employment). In Revenue Ruling 2009-31, the IRS provides that unused PTO that would otherwise be forfeited could be converted and contributed to a 401(k) plan as an employer nonelective contribution (subject to the IRC §415 limit), or, if the value of the unused PTO would otherwise be paid out to the employee, it may be converted to a salary deferral to the 401(k) plan at the employee’s election (subject to the IRC §402(g) limit). It is important to note that if the contribution is made as either a non-elective employer contribution or deferral, the plan must include it in nondiscrimination testing under IRC §401(a)(4).
Hurdles to this arrangement may include
Payroll and recordkeeper coordination;
Many off-the-shelf 401(k) documents do not permit PTO conversions without customization;
Constructive receipt issues;
Late deferral elections;
Inconsistent application among employee groups.
Although it may be challenging to coordinate, permitting participants to convert unused PTO to 401(k) contributions can be a helpful way to encourage additional retirement savings.