Common Problems & Real Solutions
This section of the web page describes examples of common operational and administrative errors in qualified defined contribution plans as defined under Internal Revenue Code Sections 401(a) and 401(k).
Source Document - The correction methods described here are based on guidance set forth in the Internal Revenue Code and corresponding Treasury Regulations, as well as in the Employee Plans Compliance Resolution System (EPCRS). EPCRS was developed by the Internal Revenue Service (IRS) to provide plan sponsors with guidance relating to the correction of certain operational plan failures. Under EPCRS, certain failures may be self-corrected by the plan sponsor under the section of EPCRS known as the Self-Correction Program (SCP). Correction of other more significant errors may be corrected under the Voluntary Correction Program (VCP) section of EPCRS which requires a special filing to be submitted to the IRS. The IRS Fix-It Guides provide an overview of EPCRS including a link to the complete EPCRS program and may be accessed at: http://www.irs.gov/Retirement-Plans/401(k)-Plan-Fix-It-Guide.
To the extent an operational plan failure implicates ERISA, plan sponsors may seek relief through the Department of Labor’s Voluntary Fiduciary Correction Program (VFCP). VFCP is designed to encourage employers to voluntarily comply with certain provisions of the Employee Retirement Income Security Act (ERISA) and is available at: http://www.dol.gov/ebsa/newsroom/fs2006vfcp.html.
Operational or Administrative Error
Exclusion of Otherwise Eligible Employees – When a plan sponsor does not notify an employee that the employee has met the eligibility requirements of the plan, the employee misses the opportunity to begin making contributions to the plan as of the employee’s eligibility date. EPCRS provides a specific method for correcting this failure. Generally, the correction requires that the plan sponsor contributes to the plan the missed employee contributions in the form of a Qualified Nonelective Contributions (QNEC), along with any related employer match. Note that the exact correction method will vary depending on the specific facts of the situation therefore, each failure must be reviewed carefully to insure that it is corrected in accordance with the EPCRS guidance for that specific failure.
Fact pattern for Plan X - The sponsor of Plan X, a 401(k) plan, excluded from plan participation 10 employees who were otherwise eligible for the plan in 2012. The plan sponsor neglected to inform these employees that they had met the plan eligibility requirements and plan entry date during the 2012 plan year therefore, these employees missed the opportunity to make an elective deferral for all or a portion of the 2012 plan year. The 10 excluded employees met the eligibility and plan entry date requirements at various times on or after the start of the 2012 plan year. They were excluded from contributing from the date they met the eligibility requirements and plan entry date through the end of the 2012 plan year. The error was discovered December 3, 2012. However, the affected employees were provided with enrollment materials in sufficient time, after discovering the error, to allow them to elect to enroll for the entire 2013 plan year. Therefore, corrective action is needed only for the 2012 plan year.
- intends to comply with the qualification requirements of Section 401(a) of the Internal Revenue Code
- is a 401(k) plan that permits pre-tax elective deferrals up to the regulatory limit for the year
- provides for an employer match on elective deferrals that is 100% of the first 5% of elective deferrals
- has eligibility requirements that are attainment of age 21 and 1000 hours of service during the plan year for all purposes
- has a plan entry date that is the date the eligibility requirements are met
- has a plan year of January 1 to December 31
- is not an ADP/ACP safe harbor plan
- does not permit catch-up contributions
- does not permit post-tax voluntary employee contributions
- does not permit Roth contributions
Correction Method - The exclusion of 10 employees who were otherwise eligible to participate in the plan during the 2012 plan year is an operational error that may be corrected under the SCP, Part IV and Appendix B of EPCRS, as described below. Note that this correction is not available for use until after the ADP test for the plan year in which the error occurred is run and corrected (if the test fails). This is because year-end data is needed to determine the amount of the corrective contribution to make up the missed elective deferral (as described in the following paragraph) and because corrective contributions must be limited to the extent they would exceed any regulatory or plan limits. The correction method is based solely on the facts presented above, the method for correcting exclusion of eligible employees is similar but not identical in other situations (e.g., the correction method is similar but not identical for a safe harbor ADP/ACP plan; for failure to implement an employee’s election to defer; for failure to allow employees to elect and make after-tax employee contributions, other than Roth contributions).
Exclusion from elective deferrals – To correct this failure the Plan Sponsor makes a QNEC on behalf of the excluded employee. A QNEC is an employer contribution that is: 1) treated like an elective deferral contribution, 2) must be 100% vested when contributed and 3) is only available for withdrawal upon attainment of age 59 ½ (if the plan provides for this option), at death, disability, severance from employment or termination of the plan. The appropriate QNEC is equal to the missed deferral opportunity. The missed deferral opportunity is an amount equal to 50% of the employee’s missed deferral. The missed deferral amount is determined by multiplying the actual deferral percentage (ADP) of the employee's group (either highly or nonhighly compensated) at the end of the plan year in which the error occurred by the employee's plan compensation for the portion of the year during which the employee was improperly excluded. The corrective QNEC will be 50% of the resulting number.
Match on excluded elective deferral amount - The appropriate correction for the failure to make matching contributions for an employee because the employee was precluded from making elective deferrals for a portion of the plan year, is for the employer to make a matching contribution that is equal to the matching contribution that would have been made for the employee if the employee’s elective deferrals for that portion of the plan year had been made during the year. In other words, although the correction for the exclusion from elective deferrals is only 50% of the missed elective deferral, the corrective match amount must be based on 100% of the missed elective deferral amount.
Special rule for brief exclusion from elective deferrals – A plan sponsor is not required to make a corrective contribution with respect to elective deferrals if the employee has been provided the opportunity to make elective deferral contributions under the plan for a period of at least the last 9 months in that plan year and during that period the employee had the opportunity to make elective deferral contributions in an amount not less than the maximum amount that would have been permitted if no failure had occurred. However, the plan sponsor is required to make a corrective contribution of any matching contributions related to 100% of the missed elective deferrals for the employee for the plan year (as described above).
Earnings must be included – The corrective QNEC and employer match must be adjusted to include earnings using one of the earnings calculation options described in EPCRS Appendix B, Section 3 Earnings Adjustment Methods and Examples.
Documentation of the error – A correction under SCP does not require an IRS filing. However the plan sponsor must document for its files and for audit trail purposes a description of the error, how the error was corrected and what steps the sponsor has taken to insure that the error will not reoccur.
Important Information! - The response provided above is based specifically on the fact pattern described above. Any variation from this fact pattern may result in a different response or variation in the correction method. This information is being presented for educational purposes only. Neither ING or its affiliated companies or representatives offer legal and/or tax advice. Plan sponsors, and if applicable, participants, should contact their legal and/or tax advisors regarding the facts and circumstances around their plan and the applicability of the issues discussed above.