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401(k) deferral elections not made


Guest skc

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Participant elected to defer 18,000 in 2005 (14,000+4,000 catchup). Payroll stopped deferrals at $14,000. Participant got W2 and is not happy. What is recommended course of action?

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Q does the plan permit catch ups? If not then employees cant make additional contributions. If payroll stopped the contributions there are two choices- If employee is not HCE ER could make 4k contribution to plan for 05 to correct error-check plan- or tell employee nothing can be done now because year is closed and employee was not harmed because he recieved 4k as wages.

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Plan does allow catch up and employee is NHCE.

Plan is silent on issue.

Employee does feel harmed because of taxes paid on $4,000.

Employer doesn't want to contribute $4,000 to employee.

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I dont know what remedy the employee has because the failure to remit contributions was not a failure of the plan because the mistake was made by the employer not the plan administrator and the pay was not a plan asset. It would be different if the employer withheld the funds from the employee's paycheck and failed to remit to the plan but this is not the case. Also doesnt the employee have an obligation to review his paystub to see if deductions were made? I dont think the employee is entitled to reimbursement of the taxes because the employee has received the funds and the employer hasnt benefitted from not making the contributions since the taxes were remitted to the IRS.

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How is it a plan violation if employer fails to withhold 401k contributions- salary is not plan asset until separated from wages. Failure to make a plan contribution is not a qualfication issue.

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Why is this different than, say, Appendix B Section 2.02(1)(a)(ii)(B) of EPCRS in regard to failure to allow eligible employees the ability to defer for part of the year??? If the plan terms say you will allow eligible employees to make elective deferrals and you don't, then you potentially have an operational violation. Catchups have a universal availability rule that also needs to be satisfied.

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Its a difference in who is responsblie for the failure, the plan adm or the employer. Eligibility is a function of the plan admin. Withholding wages is the responsibility of the employer. The failure of the employer to collect the contributions from the employee's salary cannot be attributed to the plan any more than the failure of the employer to make a contribution required under the plan by the date for filing the tax return can be an operational failure of the plan.

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I think that you're thinking about ERISA and the differences between plan administrator and other plan fiduciaries versus the sponsor and settlor responsibilities. I'm talking about Internal Revenue Code and the party claiming the deduction (employer) wanting it to be a qualified plan and the employer having responsibility for operational errors.... In an IRS audit, it's generally the employer on the line.

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But how does the failure of the employer to remit a contribution to the plan trustee become a qualification failure. Last time I looked the failure of the employer to make a contribution even if required under 412 does not affect the qualification of the plan.

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I read the posts as being regarding an operational failure rather than a qualification fialure.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Isn't an operational error a subcategory of qualification error? From the EPCRS: "The term 'Qualification Failure' means any failure that adversely affects the qualification of a plan. There are four types of Qualification Failures: (a) Plan Document Failures, (b) Operational Failures, © Demographic Failures, and (d) Employer Eligibility Failures." I don't think that the plan is even remotely at risk of being disqualified here. But I also don't think that you tell the employee "Too bad, so sad...but there's nothing we can do."

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You are still at the basic question of whether the failure of the employer to remit a contribution to the plan is a qualification issue for the plan since the plan is not responsible for making contributions to itself. No payroll system is perfect and there are numerous ways in which contribution failures occur including not changing the deferral, failing to enter/stop deferrals, etc. If you want to treat each failure a DQ issue then knock yourself out but I dont think it is required. Most employers provide disclaimers that the employee is responsible for checking deductions/withholding on their pay stub and to notify the employer in the event of errors. Secondly I dont know what the remedy would be since the employee was not cheated of any comp due him and the employer did not benefit from the failure to deduct the contributions.

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I disagree. The issues of plan administrator, plan assets, late deposits are all ERISA issues that have to do with the dollars themselves. On the Internal Revenue side, the employer has significant responsibility in ensuring that the rules are followed -- including the terms of the plan and employee elections. I think we'd have huge problem if employers are completely free to ignore any deferral elections without any repercussions.

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Guest Pensions in Paradise

mjb - in my experience at least 95% of "Employers" are also the "Plan Administrator." So are you telling me that as an attorney you would stand before the IRS and actually make the argument that the "Plan Administrator" is not responsible since withholding is the responsibility of the "Employer"?

I agree with E that this is an operational failure which needs to be corrected.

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How is fiduciary duty of a plan administrator under ERISA related to the qualified status of a plan under IRC 401(a)? Most employers designate an individual to perform the duties of plan administrator under ERISA. You have a cite for your statement that 95% of employers are plan adminstrators. Finally how do you propose to correct the operational failure?

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Guest Pensions in Paradise

The only reason I brought up "Plan Administrator" is because you are making the argument that the "Plan Administrator" is not responsible if the Employer fails to follow the terms of the plan. As far as qualification issues go, look at IRC 401k(k)(2)(A) - a qualified cash or deferred arrangement is any arrangement "under which a covered employee may elect to have the employer make payments as contributions to a trust under the plan..." It is a stretch to say the plan satisfies this requirement if the employee makes an election but the employer fails to comply with such election.

Also see Section 5.01(2) which states that a qualification failure includes an operational failure to follow the terms of the plan.

As far as a cite for my statement that 95% of employers are plan administrators, if you read my original post you will note that I said "in my experience." My experience includes over 1100 retirement plans which my firm administers. Granted, a drop in the bucket, but I believe a good representation of small to mid-size plans.

Correction would mirror the EPCRS correction method for exclusion of an eligible employee. That is, the employer would make a corrective contribution on behalf of the employee equal to the amount which was not deferred. Does this mean the employee is enriched because of the employer's mistake. Yes, but what is wrong with that? If the employer/plan administrator/trustee/fiduciary had followed the terms of the plan in the first place then the mistake would not have happened.

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Your remedy would result in unjust enrichment of $4000 to the employee who received all of his comp due him. The employee should not be rewarded for his failure to look at his paystub to see that 401k withholding stopped at 14,000.

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Guest Pensions in Paradise

And yet you feel the employee should be penalized because of the failure of the employer to follow the terms of the plan. My opinion is that if the participant does something wrong, it's the participant's fault and the participant should be held responsible. If the employer does something wrong, the employer should be held responsible. But I guess I'm a dying breed.

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In response to the question of employee's responsibility to look at their paychecks, I've heard high level IRS personnel joke that they don't like to look at their paychecks so they don't hold other employees to doing that every single paycheck. They have yet to answer how many paychecks have to be wrong before the employee bears any responsibility. But they seem to understand that at some point there should be a limit.

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There is a general misunderstanding that employee's should understand their responsibilities even if they haven't been communicated to them. It is easy to assume an employee would check his paycheck stub to see if his election was properly applied AND then report the error. This expectation is a procedure, not a qualification requirement; the procedure should not only be communicated when the election is made, but again after payroll has been run. This could be a simple email reminder to check the pay stub. But, this guarantees nothing and we are back to the plan administrators (who ever they are) ensuring the plan operates properly -- this includes an audit of the plan transactions. If an audit is not done on a regular basis, then these errors will not be caught until it is too late. I don't think there is any thing that puts plan administration requirements on the employee's shoulder and they would generally win if they pushed their case. Meaning, Mr Employer would have to pony up $4k.

I would say it's a plan operational failure that should be corrected upon discovery.

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Jean: Audits dont catch everthing because they only collect samples. You want to tell me in what forum the employee would win his case if he doesnt look at his w-2? The problem could have been fixed if the employee had provided notification before yr end. Many 401k plans have specific provisions requiring the employee to notify the plan administrator of errors in salary reduction elections and provide disclosure of such notice in the SPD.

This is no different than provisions in DB plans that require the ee to give prompt notification to the plan admin before the benefit is paid if the actual SS benefits are less than the amount shown on their benefit statement.

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Had a somewhat similar issue on a plan that we were auditing. The employee deferral election agreements were signed electing percentages and the withholding in the payroll system went in as dollars (calculated as a percentage of what the employee's compensation was at the time that the dollar amount withholding was set up in the payroll system). Not a problem except that the dollar withholdings were never updated for compensation increases.

Talked with IRS and sent in an offer that the employer would send in half of the additional amount that should have been withheld for each employee along with the full amount of any matching that the employee missed out on due to the error. Also made up earnings on the amounts. Pretty significant numbers since the problem spanned several years.

Waiting to hear from the IRS on the submission, however, per phone conversations with the Chicago office, this was the reasonable correction that they proposed.

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Cannot speak to DB rules as I have no experience in them. Prehaps my DC correction approach is parochial, but I believe that a procedure that requires an employee to report an error, and that employee fails to do so, would not in and of it self mean that the plan administrator has no responsibility to correct the error. Procedures are good, they are a safety net. I'm quite sure the average employee would not blink when their plan administrator told them they had a responsibility to report an error and because they did not, no action can be taken. But, I believe the failure to take corrective action is where the procedure is questionable.

Procedures fail all the time, that's what makes administration so much fun. What would be the proper correction for an employee that defers more than he elected to and the error isn't reported by the employee? Presumably a procedure to report a payroll deduction error would not make an exception for the dollar amount involved. If no statutory limit are exceeded, what would be the proper correction.

I agree with previous post that "On the Internal Revenue side, the employer has significant responsibility in ensuring that the rules are followed -- including the terms of the plan and employee elections. I think we'd have huge problem if employers are completely free to ignore any deferral elections without any repercussions."

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This is a very interesting post. And I'm having a hard time determining which side I come down on, because there are reasonable points on each side. So I'm going to ramble for a bit.

As far as correction - I don't believe tha Plan Administrator can correct this. In other words, withholding, failure to withhold, or an employer "correction" contribution of 4,000 are all things that the employer must authorize. The Plan Administrator can tell the employer that these things must/should/can be done, but cannot do them. And while I recognize that in many small plans the employer and Plan Administrator are one and the same, they do wear different hats for different purposes.

So let's suppose for a moment that the Plan Administrator tells the employer that there should be a makeup contribution of 4,000. And the employer refuses. Where does that leave you? The only real "harm" to the employee is that the employee paid taxes (assume combined federal/state rate of, say, 33%) of 1,320. He has the balance of the 4,000 which was paid to him as wages. And this 1,320, if it had been contributed to the plan, is only tax deferred - it will be taxed at a future date. So the only real "loss" would seem to be the potential difference in tax rates, and the effect of tax deferred compounding of interest. On this amount of money, for someone who is at least 50 already, this doesn't seem like a tremendous amount of money. For this, he should receive a 4,000 windfall?

That's just my gut feeling on the issue of what is "fair." For you attorneys, does the Plan Administrator have standing to bring suit if the employer refuses to contribute this? If so, is legal action required by the Plan Administrator? If not, the employee must either sue, or sic the DOL on the employer. Does the employee really want to open this can of worms for the money involved? I wouldn't, as the employee, 'cause employment can always be terminated or made so miserable that it is no longer an option.

As far as the plan operation itself, is it truly a disqualification issue? The "plan" has operated as well as it is able - this is an employer/payroll issue, I think. I've never seen any specific guidance on this issue - has anyone ever discussed this, even informally, with IRS representatives? Seen it on a plan audit? Might be a very good question to pre-submit for the ASPPA conference this fall, because it seems like a payroll/withholding error can't be all that uncommon. I suspect that most of them get caught early enough, and are small enough, so that they get ignored or finagled somehow and fly under the radar. It does seem that no one would challenge the validity of a fix under the VCR program, but I'm not sure what the outcome would be if the employer refuses.

Of course, after all this rambling, I'm also inclined to think that if the IRS ever DID pick this up on audit, that they would be unlikely to simply ignore it and say, "oh yeah, it's ok." It seems the safer approach for the employer to make up the 4,000...

Whew! Is there an award for longest post that starts nowhere, says nothing, and ends nowhere? If so, I think I deserve nomination. Mark Twain would designate this the "James Fenimore Cooper" award.

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