Employers who have become accustomed to correcting elective deferral failures under their 401(k) plan by making a 50% corrective contribution to the accounts of affected employees may want to become familiar with new guidance issued by the Internal Revenue Service. Revenue Procedure 2015-28 modifies the existing rules with respect to 401(k) plans with automatic contribution features and 401(k) plans that have elective deferral failures of a limited duration.
Since 2006, the standard correction for elective deferral failures has involved the employer making a corrective contribution equal to 50% of the missed deferral. These rules applied to both the improper exclusion of otherwise eligible employees, as well as failures to implement employee elections.
However, effective April 2, 2015, new rules apply with respect to elective deferral failures, and employers should consider revising their procedures when such failures are identified.
Failures related to automatic contribution features
Where a failure to implement an automatic contribution feature or an affirmative election of an eligible employee does not extend beyond the end of the 9½-month period after the end of the plan year of the failure, no corrective contribution is required. This deadline is meant to correspond with the Form 5500 filing deadline.
In order to be eligible for such relief, the following conditions have to be satisfied:
1. Correct deferrals begin on the earlier of the first payment of compensation made on or after the last day of the 9½-month period after the end of the plan year in which the failure first occurred or the first payment of compensation made on or after the last day of the month after the month of notification by the affected eligible employee;
2. Notice is given to the affected eligible employee no later than 45 days after the date on which correct deferrals begin; and
3. Corrective contributions are made for any missed matching contributions and adjusted for earnings.
Employers sponsoring 401(k) plans with automatic contribution features no longer need to make the 50% corrective contribution with respect to elective deferrals that were not properly made. The only necessary corrective contribution relates to the matching contributions that would have been made.
Elective deferrals failures that do not exceed three months
In order to encourage the early correction of elective deferral failures, a new safe harbor has been established for elective deferral failures that do not exceed three months. Under this new safe harbor, no corrective contribution for the missed elective deferrals is required, provided the following conditions are satisfied:
1. Correct deferrals begin on the earlier of the first payment of compensation made on or after the three-month period or the first payment of compensation made on or after the last day of the month after the month of notification by the affected eligible employee;
2. Notice is given to the affected eligible employee no later than 45 days after the date on which correct deferrals begin; and
3. Corrective contributions are made for any missed matching contributions and adjusted for earnings.
Elective deferral failures often arise as a result of a single missed payroll for an eligible employee, and therefore, this safe harbor will be applicable to many failures identified by employers.
Elective deferral failures that extend beyond three months
Where elective deferral failures extend beyond three months, but do not extend beyond the end of the second plan year after the failures occurred, a safe harbor correction method is established that permits the employer to make a corrective contribution equal to 25% of the missed deferrals.
In order to utilize this safe harbor, the employer has to satisfy the following conditions:
1. Correct deferrals begin on the earlier of the first payment of compensation made on or after the last day of the second plan year following the plan year in which the failure occurred or the first payment of compensation made on or after the last day of the month after the month of notification by the affected eligible employee;
2. Notice is given to the affected eligible employee no later than 45 days after the date on which correct deferrals begin; and
3. Corrective contributions (including the 25% corrective contribution and any missed matching contributions) are made and adjusted for earnings.
Notice requirement
The notice required under the safe harbor correction methods outlined above must include the following information:
1. General information relating to the failure, such as the percentage of eligible compensation that should have been deferred;
2. A statement that appropriate amounts have begun to be deducted from compensation and contributed to the plan (or will begin shortly);
3. A statement that corrective contributions relating to missed matching contributions have been made (or will be made);
4. An explanation that the affected participant may increase his or her deferral percentage in order to make up for the missed deferral opportunity; and
5. The name of the plan and contact information.
Next steps
All employers who sponsor a 401(k) plan have encountered the issue of missed elective deferrals and many employers immediately know that proper correction has historically involved making a 50% corrective contribution. However, employers can now move away from this correction. Newly established safe harbors either remove the 50% correction contribution entirety — in the case of plans with automatic contribution features or failures that do not exceed three months — or reduce the corrective contribution to 25% in the case of failures that exceed three months but do not go beyond the end of the second plan year after failures occurred.
Employers who utilize these safe harbors may want to comply with the newly developed notice requirements, as well as ensure that correct deferrals begin no later than the applicable deadlines.
The guidance from the IRS is likely to be helpful to all employers sponsoring 401(k) plans by removing the 50% corrective contribution that many employers viewed as an unnecessary windfall to affected employees. It is also another example of the IRS’s implementing guidance that makes automatic contribution features more attractive to employers as a way to further employee retirement savings.
Timothy B. Collins is an associate in Duane Morris’ employment, labor, benefits and immigration practice group. He focuses on employee benefit matters relating to corporate transactions, executive compensation, pension and retirement programs and welfare benefit programs.
