401k Plan Error – Elective Deferral Election Failure
Managing a 401k or other employee benefit plan can be challenging. Much like a complex calculus equation there are many variables that need to be considered. There are guidelines to follow outlined in the plan documents, the Department of Labor (DOL) and the Internal Revenue Service (IRS). In addition, rules and regulations governing plan investments, recordkeeping, processes and reporting make the tasks more challenging. The complexity of the equation increases when a third-party administrator or payroll provider are involved. Although plan management errors are unusual when they do happen it’s important to address them and achieve resolution. A common error that plan sponsors sometimes make is failing to permit eligible employees to make elective deferrals. To help clients, prospects and others understand how to prevent and resolve such an error, Hanson & CO has provided a summary of key information below.
The Root Cause
Employers sometimes fail to properly include eligible employees that should be allowed to make elective deferrals based on plan rules. According to the IRS, this commonly occurs for the following reasons:
Part Time Employees – It’s common for employers to assume that that the plan doesn’t include certain employees, such as part time or other works. When this happens, they can be improperly excluded without consulting plan documentation.
Non-Deferrals – Sometimes there are employees that make the decision not to make elective deferrals in a given year. The employer may conclude that these employees are not eligible to participate in the plan and therefore exclude them when plan contributions are made, and corresponding tests run.
What’s the Solution?
If an employee was not provided the opportunity to make an elective deferral the employer is required to make a qualified non-elective contribution (QNEC) to the plan on the employee’s behalf. The QNEC acts as a replacement for the lost opportunity to a participant who was not permitted to make their elective deferrals. It’s important to note that QNECs must be 100% vested and is subject to the distribution restrictions as standard elective deferrals. The amount of the QNEC is 50% of the missed deferral determined by multiplying the actual deferral percentage for the employees group for the excluded year by the annual compensation for that year.
Depending on how long the failure has occurred the corrective actions taken by the employer change. If the failure period is less than three months, then no corrective QNEC is required. All other corrective contributions must be paid to the 401k plan before the end of the second plan year after the initial year in which the failure occurred.
Assume that an employer has a 401k plan with 10 participants with total assets of $275,000. The plan has a calendar year end with a one-year service eligibility requirement. Qualifying employees can enter the plan either on January 1st or July 1st if they qualify. According to the terms of the plan, Noelle should have been able to make elective deferrals starting January 1, 2017 but was delayed until January 1, 2018. She is a non-highly compensated employee making $80,000 per year. The employer identified the mistake in 2017.
The employer is required to make a corrective contribution for the missed deferral opportunity. Noelle’s missed deferral should be equal to the 8% ADP multiple by her salary of $80,000. The missed deferral amount, based on this calculation is $6,400 ($80,000 x 8%). The corrective contribution for the missed deferral opportunity is $3,200 (50% multiplied by the missed deferral of $6,400). The employer must make the corrective contribution of $3,200 to resolve the issue for Noelle.
Making the Correction
The Self Correction Program (SCP) may be used to report the issue assuming the corrective procedures have been put in place. Under these circumstances no fine will be assessed. If there are significant errors (other plan errors occurring at the same time) the plan sponsor needs to make the corrective contribution before December 31, 2019. If there are insignificant errors in place the plan sponsor may correct the issue beyond the two-year window. If either of these conditions are not met resolution must be obtained through the Voluntary Correction Program (VCP) or other programs which often carry fines and penalties.
There are several situations in which an employer matching contribution can be missed. It’s important to regularly review plan operations to ensure that all rules are being properly followed based on plan documents. If you have a question about how to address an elective deferral failure or need assistance with your benefit plan audit, Hanson & CO can help. For additional information please call us at 303-388-1010, or click here to contact us. We look forward to speaking to you soon.