Prevailing Wage Contributions in Defined Contribution Plans
By Kristoffer Aas, QKA, EdM
During the Great Depression, a common practice among contractors bidding for federal contracts was reducing workers’ wages; and thereby, their labor costs, to win bids. While prevailing wage laws had existed on a state and local government level for more than three decades at this time, the first and most significant federal law–protecting the workers’ and their families’ welfare–was the Davis-Bacon Act of 1931.
Applicable to federal contracts in excess of $2,000 dollars to construct, alter, or repair (including to paint and decorate) public works projects, wages prevailing in the local area were to be paid to workers who spent more than 20 percent of their time performing labor or mechanical duties on federally-financed construction projects (e.g., Veterans Affairs buildings, military bases, federal buildings, and national parks).
State laws, however, often have lower thresholds—such as California’s $1,000-dollar limit or New York’s no-limit—and include a broader range of classifications and projects. Today, 32 states have such prevailing-wage type laws or regulations, and other related federal laws have been enacted.
NOTE: More information on the Davis-Bacon and its related Acts, including the McNamara-O’Hara Service Contract Act applicable to federal service contracts and covering a wide-range of service-related jobs, can be found here.
What are prevailing wage rates?
Prevailing wage rates, determined by the Department of Labor’s Wage and Hour Division, consist of two components: a basic hourly rate and a fringe benefit rate. The prevailing wage obligation can be satisfied by providing the entire benefit as cash wages or a combination of cash wages and bona fide fringe benefits (e.g., medical care, paid time-off, vocational training, or retirement plans).
The basic hourly rate is based on the wages paid to laborers and mechanics employed on specific construction projects in the local area, the local union wage rate, or a combination of the two. It is subject to payroll taxes, including the Federal Insurance Contributions Act (FICA) tax and must be paid weekly.
The fringe benefit rate is based on employer-provided bona fide fringe benefits generally paid to workers on similar projects in the same area. Any accrued overtime in a fringe benefit rate paid as cash wages can in some states result in a required rate of time and a half. If the fringe benefit rate is paid as a retirement plan contribution instead, there are no payroll taxes and a straight rate per hour–making it the most cost-effective option for an employer.
Example: If the base pay was $40 on a project with a $10 fringe benefit rate, the $10 could be paid as cash wages ($50 total) or used for a bona fide fringe benefit, such as in a retirement plan.
NOTE: Workers’ compensation, unemployment compensation, and Social Security contributions are statutory benefits not applicable towards satisfying the prevailing wage obligation. Also, states with prevailing wage laws that do not specify a separate fringe benefit rate generally permit contractors to reduce the total prevailing wage by the bona fide fringe benefit payment.
How are contributions credited to satisfy a prevailing wage obligation in a QRP?
The plan document will specify one of two crediting methods used to satisfy the prevailing wage obligation. These methods are dollar-for-dollar and annualization. It will also determine whether work spent on nongovernment projects, typically ineligible to be used towards satisfying the prevailing wage obligation, can be included.
The dollar-for-dollar method is most commonly used and requires immediate eligibility and immediate 100 percent vesting of the prevailing wage contributions.
Immediate eligibility in this context means immediate availability: only those who have satisfied the plan’s eligibility requirements immediately receive the contributions and there can be no allocation conditions. Those not yet, but expected to become, eligible can also be included.
Immediate 100 percent vesting is required, and a plan is considered to meet this requirement if no more than 500 hours of service are required to attain 100 percent vesting.
NOTE: Employees who have not yet satisfied the eligibility requirements or are not expected to become eligible, such as employees in an excluded class, must instead receive cash wages only or a combination of cash wages and a different bona fide fringe benefit than a retirement plan benefit.
Example 1: In 2023, a participant worked 1,000 hours on eligible government projects and 1,000 hours on ineligible government projects. If the fringe benefit rate remained at $10 per hour for the entire year, the employer could credit $10,000–dollar-for-dollar–towards the fringe benefit obligation.
The annualization method, on the other hand, is used by employers that do not provide immediate eligibility or immediate 100 percent vesting of prevailing wage contributions. The employer can only credit a pro rata portion of these contributions towards the fringe benefit requirement based on hours worked in eligible government projects compared to total hours worked for both eligible and ineligible government projects.
Example 2: Using the same scenario as above, a participant worked 1,000 hours on eligible government projects and 1,000 hours on ineligible government projects in 2023. The fringe benefit rate remained at $10 per hour for the entire year and the fringe benefit obligation for 2023 was $10,000.
Annualization: 1,000 hours of eligible work / 2,000 total hours of work = 50 percent
Credit per hour: 50 percent x $10 per hour = $5
Credit per year: $5 per hour x 1,000 hours of eligible work = $5,000 credit (or 50 percent of $10,000 dollars).
Total fringe benefit obligation: $10,000 - $5,000 credit = additional $5,000 required to be spent on either cash wages or other bona fide fringe benefits than the retirement plan.
What are the accounting requirements in a qualified retirement plan?
Separate accounting
While prevailing wage contributions can be allocated in their own plan, if contributed to a plan with other contributions, they must always be tracked separately.
Fringe benefit plan funding
When a plan is funded, the contractor makes irrevocable contributions, at least quarterly, to a trustee (who assumes fiduciary responsibility) of a trust or fund not affiliated with the contractor pursuant to a plan or program such as a retirement plan. Presuming all requirements have been met, the contractor will be considered to have met its obligation without prior DOL approval.
An unfunded plan, however, is any plan funded from the contractor’s general assets such as, vacation or sick leave plans. The contractor can take credit for the costs incurred from these plans if certain criteria are met—including that the plan has been communicated to the employees in writing. The contractor must receive prior approval from the DOL to use an unfunded plan and must set aside funds to ensure that these benefits are available when the workers become eligible to use them.
Eligibility and Vesting Impact on Crediting Method
If prevailing wage contributions include immediate eligibility, no allocation conditions, and immediate 100 percent vesting, the dollar-for-dollar method can be used to credit them in the retirement plan. If the contributions do not satisfy all three provisions, the plan must use the annualization crediting method.
If the benefit is not immediately 100 percent vested, it is subject to a statutory vesting schedule.
Other Contribution Considerations
Prevailing wage contributions can generally be designated as qualified nonelective contributions (QNECs) or profit sharing contributions for such purposes as plan testing, distributable events, etc., but not for eligibility, vesting, and allocations. Following are some special considerations.
Forfeited prevailing wage contributions cannot be used to satisfy future prevailing wage contributions.
The contributions generally must be deposited quarterly. An exception applies for profit-sharing plans, which can escrow quarterly and fund annually.
Because additional testing may be required if highly compensated employees (HCEs) receive prevailing wage contributions, most employers pay HCEs prevailing wage contributions as cash ONLY.
Prevailing wage contributions can be elected to offset other employer contributions, such as profit-sharing or safe harbor contributions. The prevailing wage contributions used in this manner will also take on any protected benefit rights that such employer contributions may hold in the plan—such as 100 percent vesting or certain distributable events.
