You Improperly Excluded an Employee from Your 401(k) Plan- Now What? Part 3: IRS Exceptions
Our original blog post explained that the correction procedures for an elective deferral failure included the employer making a contribution equal to 50% of the employee’s missed deferral, but noted that the percentage contributed could be reduced to 25% or 0% if one of the IRS exceptions apply. It is now time to discuss those exceptions and find out when an employer can make a smaller corrective contribution. We will continue to illustrate the required contributions through the example of Karl and ABC Company.
The first exception completely eliminates the QNEC for the missed deferral opportunity, and is for employers that find and make a correction within 3 months of the initial failure or no later than the first payment of compensation made on or after the end of the month following the month of notification if notified of the failure by the employee sooner. To illustrate, again assume that ABC Company hires Karl late in 2017, and Karl should have been eligible for the 401(k) plan on January 1, 2018. The plan operates on a calendar plan year, is subject to ADP testing, and provides for a matching contribution of 100% up to the first 4% of compensation. Further, the ADP for Karl’s employee group for 2018 was 3%, and Karl’s annual compensation was $100,000. But now assume ABC did not defer any of Karl’s compensation until the mistake was recognized by ABC and corrected in the first pay period of March.
ABC Company can correct this failure without making a contribution for Karl’s missed deferral opportunity because the failure was corrected within three months of the initial failure and before Karl notified the plan of the problem. But to use this correction method, ABC must also contribute the missed matching contribution and comply with notice requirements discussed below.
The second exception reduces the QNEC for the missed deferral opportunity from 50% to 25% of the missed deferral, and can be used by employers that find and make a correction within the 2-year window of the SCP correction period for significant failure or no later than the first payment of compensation made on or after the end of the month after the month of notification if notified of the mistake by the employee sooner. Again, assume that Karl’s situation is the same as above, except that the mistake was found and corrected after a full year of failure.
Using the second exception, ABC Company can correct the failure by making a contribution for Karl’s missed deferral opportunity equal to 25% of Karl’s missed deferral. Karl’s missed deferral is $3,000 ($100,000 * 12/12 * .03), so ABC must contribute $750 to Karl’s account, adjusted for earnings. But to use this correction method, ABC must also contribute the missed matching contribution and satisfy the notice requirements discussed below.
Both exceptions require ABC to make contributions for the match that would have been required had the missed deferrals been made. ABC must match 100% of the missed deferral up to 4% of Karl’s compensation. For the deferral corrected after 2 months of failure, the missed deferral is $500 ($100,000 * 2/12 * .03), so ABC would have to make a missed match contribution of $500, adjusted for earnings. For the deferral corrected after 1 year of failure, the missed deferral is $3,000 ($100,000 * 12/12 * .03), so ABC would have to make a missed match contribution of $3,000, adjusted for earnings.
The final requirement that ABC Company must satisfy is the notice requirement. ABC must provide a notice to Karl no later than 45 days after the date on which the correct deferral begins. The notice must contain general information relating to the failure, a statement that the appropriate amount will now start to be deducted from Karl’s compensation, a statement that Karl can make an affirmative election to change his deferral amount, a statement that the missed matching contribution has been made, and details about how to contact the plan.
The benefit to the employer for both of these corrections is to reduce the contribution amount for correcting the employee’s missed deferral opportunity. But if the employer cannot meet the requirements of either of these exceptions, the employer can still make use of the general correction method