Cash incentives, including signing bonuses and other incentive-based compensation, are a common means of attracting and motivating employees, especially in a tight labor market. For a variety of reasons, not all employees satisfy their contractual obligations and must repay compensation received.

A "clawback" happens when compensation that has already been paid to an employee must be returned to the employer. When that happens and an employee has elected to make a 401(k)-deferral based on the clawed-back amounts, it can create substantial headaches for the employer—especially if the employer has also made a matching contribution based on the deferral. Employers who use clawback provisions should be aware of some valuable steps they can take to protect themselves—and know that it's critical to pay attention to the letter of the law to avoid plan disqualification.

Clawbacks & 401(k) deferrals: The basics

Typically, employers may recover already-paid compensation from an employee who fails to satisfy contractual obligations that are tied to cash incentives paid up front. These types of clawback provisions are often included in contracts between the employer and employee. In many cases, the employee must repay amounts that have already been paid with interest or penalties.