- Mark Nicholas
On-Demand Pay: An Administrative Trap?
One of the hottest trends in employer benefits is offering on-demand pay, allowing employees to meet short term liquidity needs between paychecks without incurring the high cost of payday lenders. While there has been much discussion in payroll circles about how to manage tax treatment of on-demand pay, there has been little discussion on the nuances this service brings to retirement plan administration. Below are some questions that retirement plan sponsors should consider when offering on-demand pay:
Does the pay count as plan compensation when it's paid or when it's scheduled?
Plan documents typically define plan compensation in a manner that aligns well with traditional payroll practices, but it may not be as clear when it comes to on-demand pay. For example, if an employer's last regular payroll date in a plan year is December 23rd, but an employee requests and receives additional compensation on December 30th, does the on demand compensation received on the 30th count as compensation for the plan year ending December 31st? The existence of different business models makes this more interesting with the Bureau of Consumer Financial Protection differentiating between certain models for Reg Z compliance, determining if Truth In Lending disclosures are needed. Further, Treasury suggested in the 2022 Green Book that legislation be enacted to cause the on-demand pay be treated as a weekly payroll to add clarity around tax payments, which opens up the possibility for the pay to be treated one way for Reg Z, another way for tax payments and potentially a different way for plan compensation. Since plan compensation is essential for compliance testing and contribution calculations, understanding whether on-demand pay counts as plan compensation is critically important.
How does on-demand pay effect mid-period deferral rate changes?
Plan participants, generally, cannot make or alter a deferral election after they have received their compensation. We know that employees change deferral elections all the time though, especially when faced with unexpected expenses, such as those that might prompt an on-demand pay request. If an employee requests payment, then changes his/her deferral election before the regular payroll date, is the employer required to use the deferral election that was in place at the beginning of the period for compensation received ahead of their change to maintain a qualified cash or deferred arrangement? I believe it may, provided the advance is not a loan, but suspect current practices may not be developed in a manner that supports this yet. It's also worth noting that Treasury proposed, in the 2022 Green Book, that the Internal Revenue Code be amended to clarify that on-demand pay is not a loan.
Does on-demand pay change when deposits are due?
Current thinking from Treasury, from the 2022 Green Book, suggests that treating on-demand pay as a weekly payroll may be prudent for tax remittance purposes but the Department of Labor has yet to weigh in on it's expectations for remitting deferrals when on-demand pay is utilized. Given the DOL's long-held belief that contributions should be remitted as soon as practicable, it would follow that there may be an expectation that deferrals from on-demand compensation may need to be remitted in advance of regularly scheduled payments to be made timely. This would (again) seem to hinge on whether the advance payment is a loan.
We've only scratched the surface of this topic here. Without legislation and/or regulatory guidance on this, we suggest plan sponsors who offer on-demand pay services and a retirement plan consult with their attorney regarding this and, at a minimum, document their considerations and decisions relating to how and when the plan will recognize on-demand pay for plan purposes.