July 5, 2022

Volume XII, Number 186

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401(k) Compliance Check #3: Don’t You Forget About Me – Addressing Participant Exclusion Errors

To help employers properly administer their 401(k) plans, in 2022, Foley & Lardner LLP is authoring a series of monthly “401(k) Compliance Check” newsletters. This article discusses the process for addressing situations where an employer improperly excludes an employee from participating in the employer’s 401(k) plan.

In last month’s 401(k) Compliance Check #2, we discussed the importance of timely depositing participant contributions in your plan’s trust or custodial account after deferral elections have been made and amounts deducted from eligible pay. In this month’s Compliance Check, we discuss what to do if an employee is not provided with an opportunity to enroll in the 401(k) plan or an employee’s election is not implemented at all.

Why is This Topic Important?

The failure to provide an enrollment opportunity or to implement an employee’s election are operational failures that put a 401(k) plan’s tax qualification in jeopardy.  Luckily, these types of compliance failures are generally easy to self-correct through the Internal Revenue Service’s Employee Plans Compliance Resolution System (sometimes referred to as “EPCRS”).1

How to Identify the Failure?

Identifying an exclusion or election implementation error can be a reactive or proactive exercise.  An employee may contact the employer to inquire about why they were never provided with an opportunity to enroll in the 401(k) plan or why their election has not been implemented.  Or, the issue may be caught on a plan audit or during an operational review. 

Once a potential error has been flagged, the plan administrator should confirm whether an error actually occurred.  In the case of an exclusion, this starts with understanding which employees are eligible for the 401(k) plan and when that eligibility begins.  The definition of “eligible employee” (or similar term) can be found in the 401(k) plan document.  Once this group has been identified, the next step is understanding whether any age or service requirements or entry date requirements in the plan will delay participation for certain employees (limitations on these restrictions will be discussed in a future Compliance Check). In the case of an implementation error, this starts with contacting the recordkeeper to confirm that the employee made an election in a timely and correct manner (or was eligible for automatic enrollment) and then confirming that the affirmative or automatic election did not start in the timeline outlined under the plan terms.

How to Fix the Failure?

EPCRS provides a “safe harbor” self-correction option to correct these failures.  The scope of the correction depends on how long the error has been ongoing and certain employer preferences.

Make-Up Employer Contributions.  Regardless of the self-correction method used, the employer must always contribute an amount equal to 100% of the employer contributions that would have been made, plus earnings.  For matching contributions, this amount is calculated with respect to the full missed deferral opportunity2 – not the amount of the corrective contribution outlined below.

PLUS:

50% of Missed Deferral Opportunity.  As long as corrective contributions are made before the last day of the second full plan year after the plan year in which the failure first began,3 then the error may always be corrected by making a corrective contribution related to the missed deferral opportunity equal to 50% of the missed deferral opportunity, plus earnings. This is the “required” safe harbor method for any employee who is not employed at the time of the correction.  It is also permitted, at the plan administrator’s election, even if the plan qualifies for the modified corrections outlined below.

OR

Reduced Corrective Contribution.  If the affected employee is still employed on the date of correction and the employer provides a 45-day notice4 of the correction, then the employer may decide to make a reduced corrective contribution related to the missed deferral opportunity.  Specifically:

  • 0% of Missed Deferral Opportunity. The corrective contribution related to the missed deferral opportunity may be reduced from 50% to 0% if correct deferrals begin by the first pay date occurring on or after the earlier of:

    • The last day of the month after the month in which the employee notified the employer of the failure; or

    • The last day of the three-month period that begins when the failure first began (or, if the plan has an automatic enrollment feature and the correction is made prior to 2024 (unless re-extended by the IRS), the date that is 9½ months after the end of the plan year in which the failure first occurred).

       

  • 25% of Missed Deferral Opportunity. The corrective contribution related to the missed deferral opportunity may be reduced from 50% to 25% if correct deferrals begin by the first pay date occurring on or after the earlier of:

    • The last day of the month after the month in which the employee notified the employer of the failure; or

    • The last day of the second full plan year after the plan year in which the failure first began.

Are there Other Best Practices?

Other best practices around this type of issue and related correction include:

  • Keeping a record of the error and the correction. Although not required by EPCRS, this type of contemporaneous record will help if the plan is ever audited and the auditor asks questions about the error. It may also help in connection with due diligence in the context of a future corporate transaction.

     

  • Regularly review and ensure the accuracy of employee data in the plan’s recordkeeping and payroll systems, including dates of hire and termination, birth dates, hours worked (if applicable in the plan), and election information and history.

Encouraging employees to check their plan balances regularly and inform the employer of any issues they see as soon as practicable.


1 Rev. Proc. 2021-30.

2 For exclusion errors, the “missed deferral opportunity” is determined by using the actual deferral percentage for the employee’s group (HCE or NHCE) in the plan for the year of exclusion.  For enrollment errors, it is generally determined using the percentage elected (or deemed elected) by the employee.

3 Errors corrected after this deadline must be corrected under the IRS’s voluntary compliance program.

4 The notice must (i) be provided within 45 days of commencement of correct deferrals, and (ii) include information on: the failure, the corrective contribution, the commencement of correct deferrals, the opportunity to increase deferrals going forward and plan contact information.  Some employers would rather not provide the notice and, as a result, opt for the 50% correction method.

© 2022 Foley & Lardner LLPNational Law Review, Volume XII, Number 76
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About this Author

Casey Knapp Corporate Attorney Foley & Lardner Law Firm
Partner

Casey K. Fleming is a partner at Foley & Lardner LLP where she focuses her practice on employee benefits and executive compensation. Ms. Fleming’s employee benefits work includes advising private and public employers on the issues that affect retirement plans, health and welfare benefit plans, non-qualified deferred compensation plans, executive compensation and severance arrangements, and employment agreements.

Retirement Plans

Ms. Fleming’s work with qualified retirement plans includes assisting clients with the design and implementation of 401(k) plans, profit...

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