Non-Elective Contribution (2024)

A non-elective contribution is a fully-vested payment made by an employer to an employee-sponsored retirement plan, regardless of whether the employee makes an elective deferral. The contributions are not deducted from the employee’s monthly income but are paid directly by the employer.

Non-elective contributions differ from matching contributions, where an employer contributes to an employer-sponsored retirement plan depending on the amount of money that is deducted from the employee’s monthly salary toward the retirement plan.

Employees benefit from the non-elective contributions because the contributions that the employer makes towards the retirement plan helps max the contribution limit beyond what they can achieve on their own. However, the contributions are made at the discretion of the employer and they may change at any time.

Understanding Non-Elective Contribution

The amount that an employer contributes towards a non-elective contribution varies from one employer to another. An employer is free to set or change the non-elective contribution rates as they see fit. However, the amount that an employer contributes towards the plan should not exceed the limits set by the US Internal Revenue Service (IRS).

For example, an employer may decide to contribute 10% of the employee’s salary towards the retirement plan. This means that, for every one dollar of salary, the employer will contribute 10 cents, regardless of whether the employee makes an elective deferral towards the plan.

An employer can also make a non-elective contribution as part of a safe harbor contribution 401(k). A safe harbor allows employers to avoid most annual compliance tests that can result in refunds and penalties. It is a way to structure retirement plans that pass the nondiscrimination tests.

The provision requires the employer to make contributions to each employee’s retirement plan at a uniform percentage of at least 3% of the employee’s salary. By adding a safe harbor provision to their 401(k) plan, highly compensated employees are able to max out their retirement contributions, and the employer will not have to worry about the annual compliance testing.

Benefits of Non-Elective Contributions

1. Tax-deductible

One of the benefits of non-elective contributions is that the contributions are tax-deductible for the company, which can provide a significant tax break for the employer. Employers who make a non-elective contribution can offset the cost of the contributions from the tax breaks they receive. Such an arrangement can also encourage more employees to take part in the company’s retirement plan since it benefits both the employer and the employee.

2. Inclusive

Non-elective contributions are also designed to benefit all employees employed by the company, rather than favoring only the highly compensated employees. By making the contributions, the employer’s 401(k) is exempted from most annual compliance tests. Highly compensated employees are those who earn more than $130,000 in annual income, those who are employed in the company, and who own at least 5% of the company, or those who are part of a family that owns at least 5% of the company.

If an employer’s plan fails compliance testing, the highly compensated employees may be limited in what they can contribute towards their 401(k) plans, and the IRS can reject a retirement plan contribution when it is considered excessive.

3. Motivating factor

Another benefit of non-elective contributions is that it may be the only money the employee is putting into their retirement. A significant number of employees do not keep a 401(k) plan or a retirement savings account, which leaves them even more vulnerable. By giving such employees non-elective contributions, an employer motivates the employees to contribute to their 401(k) plan.

Limitations of Non-Elective Contribution

1. Higher administrative costs

One of the challenges that employers face when making non-elective contributions to an employee’s retirement plan is that it creates additional administrative costs that will be costly to the employer in the long term. An employer also takes on additional responsibilities of choosing retirement plans and deciding the default accounts for employees who do not select a fund for their 401(k) contributions or manually enroll in a retirement plan. Although employers enjoy tax breaks from the contributions, they may not be feasible for most employers.

2. Greater fiduciary liability

Another limitation of non-elective contributions is that they increase the employer’s fiduciary liability. The liabilities can range from enrolling employees into a retirement plan, administrative errors, delayed balance transfers, interpreting plan benefits, etc.

Assuming a fiduciary role comes with risks, it can lead to potentially expensive court battles and put future earnings at stake. When making non-elective contributions, an employer will need to educate its employees on retirement planning and how to choose the right plans that match their retirement goals.

Related Readings

CFI is the official provider of the global certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• 401(k) Contribution Limits
• Pension Fund
• Variable-Benefit Plan
• Safe Harbor
• See all wealth management resources