Correcting Retirement Plan Errors with Elective Deferrals by Tiffany Santhavi
Correcting retirement plan errors with elective deferrals occurs more than you might think. Administering a 401(k) plan is not an easy job and correcting retirement plan errors comes with the territory. Two common errors that plan sponsors make with elective deferral (also known as salary deferral or 401(k)) contributions are: when they fail to implement an employee’s election (so that intended deferrals are not made), or the process the election incorrectly so that the wrong amount is withheld from the employee’s paycheck and deposited to the plan.
When this happens, the employee has what is known as a missed deferral opportunity. This means that the employee was taxed on compensation that was supposed to be deferred, and the contribution failed to earn an investment return in the plan. But fear not, you are not alone in this struggle.
Let’s say that Natasha starts working at ABC Corporation, which sponsors a 401(k) plan. The plan provides for matching contributions for eligible employees equal to 100% of elective deferrals up to 3% of an employee’s compensation. On December 29, 2017, Natasha makes her first election to contribute 5% of compensation for the 2018 plan year when she becomes eligible. Her salary was $50,000 for the year. The HR manager was out on maternity leave when Natasha submitted her forms, so Natasha’s election was never processed. Close to the end of 2018, Natasha finally notices on her paycheck stub that her deferrals were never deducted from her paychecks. What does HR do now? It is time to go full-throttle into the mode of correcting retirement plan errors with elective deferrals.
Believe it or not, this is actually a very common failure. Fortunately, the IRS provides plan sponsors with guidance on correcting retirement plan errors with elective deferrals. ABC Corporation must make a corrective contribution, known as a qualified nonelective contribution, to make up the missed deferral opportunity (“MDO”) that Natasha experienced, plus earnings, and the missed matching contribution.
In most instances, the MDO is equal to 50% of the deferral rate. In Natasha’s case, since she elected to defer 5%, her MDO would be equal to 2.5%, plus missed earnings for the period in question. The next step is to calculate missed matching contributions for which Natasha was eligible and was missed because her deferral election was never processed. ABC Corporation must contribute a matching contribution to the plan on Natasha’s behalf equal to the full matching contribution Natasha would have received on her original 5% deferral. As noted above, the full amount of the deferral should have been $2,500, 5% of Natasha’s compensation. The plan provides for a 100% matching contribution up to 3% of pay. Three percent of Natasha’s compensation is $1,500 ($50,000 x .03). Thus, ABC Corporation is required to contribute $1,500 (adjusted for earnings) to the plan on behalf of Natasha as the missing matching contribution.
In some instances, the MDO can be reduced to 25% or even 0% if the affected participant is still actively employed and certain other circumstances exist. The sooner you find and begin correcting retirement plan errors with elective deferrals, the better. Notices are required to be distributed to the affected participant. You should consult with your third-party administrator to see if these lower cost options are available and how the correction is calculated.
It is important that a plan sponsor has internal procedures to ensure that deferral elections are implemented in a timely manner. Checking your payroll to confirm the deferrals on a monthly or quarterly basis can prevent mistakes from stretching into years which could result in the error costing a plan sponsor high dollars.
Tiffany Santhavi, J.D., is an associate attorney with Ferenczy Benefits Law Center in Atlanta, Georgia, where she works on all types of qualified retirement plans and related issues. Ms. Santhavi analyzes operational and ERISA compliance plan issues, advises clients with respect to corrective procedures, prepares corrective filings for submission to the Internal Revenue Service and the Department of Labor, and assists various plan service providers with reporting and disclosure requirements in their client service agreements.