Is an employee's compensation limited by the 401(a)(17) limit before calculating their ADR?

The answer is true, as the 401(a)(17) limit plays a crucial role in determining the compensation that can be considered for various retirement plan calculations, including Average Deferral Rate (ADR). This limit restricts the amount of compensation that can be included for contribution calculations under a qualified retirement plan, ensuring that only a specific portion of an employee's earnings is eligible for contributions.

This limit is particularly significant for defined contribution plans, such as 401(k) plans, as it directly impacts the contributions made on behalf of employees for both highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). When calculating their ADR, employers must apply this limit to ensure compliance with IRS regulations and to avoid excessive contributions that could lead to penalties.

The rationale behind imposing this limit is to maintain the integrity of tax-advantaged retirement savings through equitable contributions across different employee income levels. By applying the 401(a)(17) limit before calculating the ADR, plans help to balance contributions and maintain compliance with the nondiscrimination testing requirements imposed by the IRS, which are designed to ensure fairness between HCEs and NHCEs in a retirement plan.