Art by June Kim
Plan sponsors must operate their plans in compliance with notoriously complicated rules set forth in the Internal Revenue Code (IRC), none more complex than those relating to automatic contribution and automatic escalation features in 401(k) plans. If an error is left uncorrected, it can jeopardize the plan’s tax-qualified status, leading to costly tax consequences.
The Internal Revenue Service (IRS) Employee Plans Compliance Resolution System (EPCRS) is a tool for correcting operational errors, but until the recent issuance of enhancements, using it to fix failures related to automatic contributions has been viewed as too costly. This, in turn, has discouraged some sponsors from adopting such features. To remove this impediment, the IRS recently issued Revenue Procedure 2015-28, which amends EPCRS to make it easier to fix deferral errors. The relaxed procedure applies to 401(k) and 403(b) plans’ failure to effectuate automatic contributions or affirmative deferral elections by participants, as well as the failure to carry out automatic escalation of the deferral rate where called for by the plan. The new procedure also applies where an employee was improperly excluded from the plan when denied the opportunity to make an affirmative election.
Under the old EPCRS rules, correction of these failures entailed making a qualified nonelective contribution (QNEC) on behalf of the employee affected by the mistake. The amount of the QNEC was 50% of the deferral percentage for the employee’s group in the plan—i.e., either the highly compensated or the non-highly compensated group—multiplied by the employee’s compensation for the year. The old rules also required corrective contributions for missed matching contributions and lost earnings. This was criticized for providing affected employees with a windfall, because they received plan contributions in addition to their full salary.
The new rules provide a safe harbor for certain deferral failures where neglect to implement an automatic contribution or an affirmative deferral election extends no longer than 9.5 months after the end of the plan year of the failure. This is generally the extended filing deadline for the plan’s annual report on Form 5500. Under the safe harbor, if correct deferrals begin by the first payment of compensation after the earlier of this date or the date the plan sponsor is notified of the failure by the affected employee, a QNEC will not be required. The safe harbor is limited to employees subject to an automatic contribution feature.
There are two additional conditions for the safe harbor. The first requires that the affected employee receive notice of the failure—including the percentage of eligible compensation that should have been deferred and the date deferrals should have begun—within 45 days after correct deferrals start. The plan sponsor must also make a corrective contribution for missed matching contributions, adjusted to reflect earnings on the match based on the employee’s designated plan investment or, if there is none, on the plan’s default investment. The deadline for these contributions will generally be the last day of the second plan year following the one for which the failure occurred.