Correcting Retirement Plan Eligibility Errors: Improper Exclusion Leads to Corrective Contributions

Posted By: Maria Hurd, CPA

But They Got the Money in their Paycheck, Why Should They Get Even More?

When an organization does not give employees the opportunity to make salary deferrals, or ignores their election to make salary deferral contributions, correcting the mistake in accordance with the IRS Correction Program called Employee Plan Compliance Resolution System (EPCRS) can be very costly.

Allowing the improperly excluded employees the opportunity to contribute prospectively is not sufficient. In fact, EPCRS requires the employer to fund an immediately vested allocation to the affected participants’ accounts called a Qualified Nonelective Contribution (QNEC) plus 100% of what would have been the match on the entire deemed missed deferral amount. The employer contribution portion can be subject to the plan’s vesting schedule.

Understandably, the employers often argue that improperly excluded employees received their whole paycheck, such that contributions to their retirement account funded by the employer are a windfall to the plan participant. In their view, the required employer-funded corrective contribution is not fair and equitable to the other employees who had to forgo part of their paycheck to save for retirement. Arguably, they have a valid point, but the rules are designed to protect retirement readiness of the improperly excluded participants. However, there is some reprieve.

The corrective contribution attributable to the omitted deferral withholdings can be 0%, 25%, or 50% of the missed deferral. The entire amount that would have been the match on the entire missed deferral, not the corrective contribution amount, must also be allocated to each affected participant.

To efficiently summarize the corrective contribution options provided by EPCRS in Revenue Procedure 2021-30, we created the following chart:

Deferrals Begin by the First Paycheck ON OR AFTER Corrective Contribution Notice Requirement
First 3 months of the plan year 0% QNEC

100% match or QMAC

No Notice
A rolling three-month period beginning with the first omission 0% QNEC

100% match or QMAC

Notice Required
Automatic Contribution

Arrangement by 91/2 months    after the plan year of failure


100% match or QMAC

Notice Required
Between 3 months and the last   day of the third year after the  error occurred 25% QNEC Notice Required
After the last day of the third year after the failure or at any time 50% QNEC

100% match or QMAC

No Notice
If the participant notifies the employer of the failure, deferrals must start by the last day of the month following the notification.


But They Would Not Have Chosen to Contribute Anyway!

Another common argument against making a corrective contribution is that employees who are not participating would not have chosen to contribute anyway. Indisputably, participation rates tend to be low in industries with high turnover and/or employees making the minimum wage, but corrective contributions are required for improperly excluded employees, regardless of their industry and salary. When there is no way to know how much an employee would have contributed, EPCRS provides a mechanism to compute the deemed lost salary deferral amount.

Corrective Contribution Computation: 0%, 25%, or 50% of What?

Once the improper exclusion error is discovered, asking the participants how much they would have contributed after the fact is not an option. Astute employees would inevitably say they intended to defer the maximum unless they fear for their job security, in which case they would say they didn’t intend to save at all. EPCRS solves this uncertainty by providing pre-approved guidelines for the computation.

For 403(b) Plans and 401(k) Safe Harbor Plans, Revenue Procedure 2021-30, Appendix A.5(6) provides a safe-harbor computation for the deemed lost salary deferral amount to be the greater of:

  • 3% of eligible compensation, or
  • the maximum deferral percentage for which the employer provides a 100% match contribution (or greater)

Alternatively, employers can use the average deferral percentage of the employee’s group, (either Highly or Non-Highly Compensated Employees HCEs or NHCEs) as the base for the computation to which the corrective contribution factor is applied.

When the employer does not implement an election that was made by the participant on a timely manner, then the percentage elected by the participant should be used as the base for the corrective contribution computation.

How Auditors Find the Mistake:

From a complete census or annual payroll report including all employees, we isolate a list of eligible participants who did not make deferral contributions to the plan. For a sample of employees on that list, we determine if they received proper notification of their eligibility to participate in the plan. Most employers can provide evidence of email or paper notifications sent by the employer or the recordkeeper, attendance sheets for enrollment meetings, or other evidence of their notification process. Best practices include obtaining and maintaining written records of all participants’ elections, including when they decline participation. Direct confirmation with eligible employees who are not participating is also an option for the auditors in the absence of evidence of notification.

Best Practices for Employers

Since the arguably unfair windfall to improperly excluded participants can be costly, it is important for employers to avoid the mistake. Establishing procedures to ensure notification of plan eligibility to employees, as well as keeping a record of both, the notification and the employee’s election is important. Depending on the terms of their service agreements, many recordkeepers and third-party administrators can provide us electronic audit evidence of notifications sent on behalf of the employer and elections made by the participants. When the employer maintains responsibility over notifications and deferral elections are made on paper, employers should keep records of elections to participate, as well as elections not to contribute, as definitive proof that the employees were given the opportunity to participate in the plan. In the case of 403(b) plans, employers should provide proper notification to each employee of their eligibility to participate in the 403(b) plan at least annually to comply with the universal availability rules.

No matter what type of plan, it is important to keep records to prove compliance with the notification requirement.

When auditors are involved, if something is not documented, it didn’t happen.