Posted by Stacey Snyder
Failing to allow eligible employees to defer in an employee benefit plan can be very costly and result in plan disqualification. However, the IRS issued updates to the Employer Plan Compliance Resolution System (EPCRS) which provides plan sponsors three options for correcting the four types of qualification failures.
Types of Qualification Failures:
- Plan document failures,
- Operational failures,
- Demographic failures, and
- Employer eligibility failures.
The failure to allow eligible employees to defer in a retirement plan is considered to be an operational failure since it likely results from a failure to follow plan provisions.
Correction options provided through EPCRS:
- Voluntary Correction with Service Approval, and
- Correction on Audit.
Any of the three options are available for corrections related to operational failures, but self-correction is the only option in which the plan sponsor will not incur a fee. Self-correction can only be used if the failure is corrected by the last day of the second plan year following the year in which the failure occurred.
The correction under EPCRS for a missed deferral opportunity requires a Qualified Non-Elective Contribution (QNEC) be made equaling 50% of the participant’s missed deferral, determined by multiplying the actual deferral percentage (ADP) for the employee’s group in the plan (highly compensated or non-highly compensated) by the employee’s compensation for that year. In the case of a safe harbor plan, the missed deferral is the greater of 3% of compensation or the maximum deferral percentage for which the employer provides a matching contribution rate of 100% or greater. For safe harbor plans with a 3% nonelective contribution, rather than a match, the missed deferral is deemed to be 3% of compensation. In every case, the QNEC, or missed deferral opportunity, equals 50% of the missed deferral.
Also, if the participant would have been eligible to receive an employer matching contribution based on the missed deferral or a safe harbor matching contribution, the employer must make a corrective employer nonelective contribution equal to the entire amount the participant would have received if they had been properly included. In this case, the amount would be 100% of the match attributable to the missed deferral.
If an employee is not provided an opportunity to contribute elective deferrals to a safe harbor § 401(k) plan that uses an automatic contribution arrangement to satisfy the safe harbor requirements of § 401(k)(13), the missed deferral is generally deemed to equal 3% of the employee’s compensation under the plan. If the failure occurs for a plan year or plan years subsequent to the first eligibility year, then the missed deferral for each subsequent plan year is equal to the percentage specified in the plan document. The computation of the missed deferral in this case replaces the estimate based on the ADP test in a traditional § 401(k) plan, as explained above. The required corrective employer contribution on behalf of the excluded employee is equal to the missed deferral opportunity, 50% of the missed deferral, plus an amount equal to either the matching contribution that would apply to the missed deferral or the nonelective contribution that would have been made on behalf of the employee, whichever applies under the plan.
All corrections mentioned above need to be adjusted for earnings to the date that the correction has been made.
The EPCRS program document includes 10 examples of how to compute a correction for an improperly excluded employee from a plan providing benefits subject to 401(k) and 401(m).
Although self-correction sounds very complicated, it is not difficult once you work through the examples. However, it is costly since QNECs must be funded from the employer’s money, not the employee’s. In every case, identifying eligible employees on a timely basis is the best alternative.