Rev. Proc. 2015-28 Correction of employee erroneously excluded from 401(k) for 2015

[Carol V. Calhoun]

I've got a plan that erroneously excluded a total of three employees in 2014 and one in 2015. It looks like the employer can use the new corrections procedure in Rev. Proc. 2015-28 (requiring only a 25% QNEC instead of a 50% QNEC to make up for the lost deferral opportunity). For 2014, it's fairly clear how this is to be done. However, I've got questions with respect to 2015:

1. Is there a missed deferral opportunity at all for 2015? The Rev. Proc. says you've got to give the employee a notice saying that he or she can make up the missed deferrals, subject to the 402(g) limits. Since we're only halfway through the year, the employee should be able to defer the full 402(g) amount in the second half of the year. At the same time, the procedures are different if the error is discovered within 3 months than if it is discovered thereafter, so presumably some correction is required if the error goes on for more than 3 months but still within the same year?
2. If the employer has to make a QNEC for 2015, how is it calculated? The QNEC is based on the ADP of the HCE or NHCE group. But presumably, the ADP can't be calculated until after the end of 2015. Does the employer have to defer the contribution until after 2015 ends, or is there some way to determine the amount of the QNEC before that time?
3. The notice to the employee must include "A statement that appropriate amounts have begun to be deducted from compensation and contributed to the plan (or that appropriate deductions and contributions will begin shortly)." What does this mean in the context of employee elective deferrals? Presumably, no amounts should be deducted from compensation until and unless the employee makes a deferral election.

[K2retire]

How are you able to meet the notice requirement within 45 days for a 2014 error at this point?

[Mike Preston]

I've got a plan that erroneously excluded a total of three employees in 2014 and one in 2015. It looks like the employer can use the new corrections procedure in Rev. Proc. 2015-28 (requiring only a 25% QNEC instead of a 50% QNEC to make up for the lost deferral opportunity). For 2014, it's fairly clear how this is to be done. However, I've got questions with respect to 2015:

• Is there a missed deferral opportunity at all for 2015? The Rev. Proc. says you've got to give the employee a notice saying that he or she can make up the missed deferrals, subject to the 402(g) limits. Since we're only halfway through the year, the employee should be able to defer the full 402(g) amount in the second half of the year. At the same time, the procedures are different if the error is discovered within 3 months than if it is discovered thereafter, so presumably some correction is required if the error goes on for more than 3 months but still within the same year?
• If the employer has to make a QNEC for 2015, how is it calculated? The QNEC is based on the ADP of the HCE or NHCE group. But presumably, the ADP can't be calculated until after the end of 2015. Does the employer have to defer the contribution until after 2015 ends, or is there some way to determine the amount of the QNEC before that time?
• The notice to the employee must include "A statement that appropriate amounts have begun to be deducted from compensation and contributed to the plan (or that appropriate deductions and contributions will begin shortly)." What does this mean in the context of employee elective deferrals? Presumably, no amounts should be deducted from compensation until and unless the employee makes a deferral election.

(1) Unless I'm reading it wrong, I think you have a situation where the error is not discovered within 3 months and therefore the correction is a 25% QNEC with respect to the missed deferrals for the entire period of failure. So, yes, there is a missed deferral for 2015 measured from 1/1/2015 through the date that deferrals are enabled. The missed deferral is calculated with reference to the ADP % for the group and is independent of the actual election the participant ends up making. So you end up with the same QNEC whether the participant elects no deferrals or max deferrals.

(2) Yes, in the case of a current year missed deferral that requires correction where the plan uses current year testing you can't calculate the missed deferral opportunity until the year is over and, if necessary, the failed ADP test is fixed (since you have to correct everything else before calculating the missed deferral), so you can't make the QNEC until the year is over.

(3) Yes, deferrals can't actually begin until the participant has filled out an election, or has been given an election form and decided not to act on it, in which case you should be able to use a cutoff date in the determination of the calculation of the missed deferral opportunity. I think the 45 days should be measured from the same cut-off date, or, if an election is made, the payroll date where such election would first be implemented (even if zero).

I'm only about 1/2 way through my notes so it wouldn't surprise me to learn that there is soft guidance supplementing EPCRS that clarifies one or more of your excellent questions.

[Carol V. Calhoun]

How are you able to meet the notice requirement within 45 days for a 2014 error at this point?

The notice requirement is "not later than 45 days after the date on which correct deferrals begin," not within 45 days after the error.

[Carol V. Calhoun]

(1) Unless I'm reading it wrong, I think you have a situation where the error is not discovered within 3 months and therefore the correction is a 25% QNEC with respect to the missed deferrals for the entire period of failure. So, yes, there is a missed deferral for 2015 measured from 1/1/2015 through the date that deferrals are enabled. The missed deferral is calculated with reference to the ADP % for the group and is independent of the actual election the participant ends up making. So you end up with the same QNEC whether the participant elects no deferrals or max deferrals.

So if the participant elects max deferrals, she ends up getting the entire 402(g) amount, plus the QNEC, even though that exceeds the amount she could have put aside for 2015 in the absence of the error? I agree this is a reasonable reading of the Rev. Proc., but it strikes me as nonsensical from a practical perspective.

Then again, other interpretations also strike me a nonsensical. We could, for example, assume that the QNEC would count as part of the 402(g) amount (even though a QNEC is not normally counted toward 402(g)), on the theory that it replaces a contribution that would normally be subject to 402(g). But given that the contribution can't be made until after the end of 2015, that would mean that there would be no way to figure out during 2015 what the maximum amount she could contribute would be.

[Mike Preston]

I think one or more of the writeups for EPCRS make it clear that the purpose of the QNEC (originally 50% now 25%) is to make up not only for the opportunity lost relative to the ability to defer, but also the missed earnings, right? So, while the participant can get back to "402(g) max" by electing a higher percentage than what would have been necessary if the election would have been effective for the entire year, he/she can never get back the lost earnings.

Here is the cite from 2015-28:

"The correction principle underlying the 50% make-up corrective contribution was that corrective contributions should make up for the value of the lost opportunity for an employee to have a portion of his or her compensation accumulate with earnings tax deferred in the future assuming the participant would not have the opportunity to increase elective deferrals in later periods to make up for missed contributions AND EARNINGS that would have accumulated until retirement."

You would think that the correction, in this case, wouldn't need a separate earnings component due to the quoted paragraph. But I can see that there is a slight disconnect and so the earnings being referenced are separate issues.

[Carol V. Calhoun]

I think one or more of the writeups for EPCRS make it clear that the purpose of the QNEC (originally 50% now 25%) is to make up not only for the opportunity lost relative to the ability to defer, but also the missed earnings, right? So, while the participant can get back to "402(g) max" by electing a higher percentage than what would have been necessary if the election would have been effective for the entire year, he/she can never get back the lost earnings.

Here is the cite from 2015-28:

"The correction principle underlying the 50% make-up corrective contribution was that corrective contributions should make up for the value of the lost opportunity for an employee to have a portion of his or her compensation accumulate with earnings tax deferred in the future assuming the participant would not have the opportunity to increase elective deferrals in later periods to make up for missed contributions AND EARNINGS that would have accumulated until retirement."

You would think that the correction, in this case, wouldn't need a separate earnings component due to the quoted paragraph. But I can see that there is a slight disconnect and so the earnings being referenced are separate issues.

Yeah, I could understand if the make-up were equal only to the earnings on the missed contribution. But the earnings appear to be a whole separate computation. And ironically, the fact that the employer cannot make up the 2015 contribution until 2016 means that more earnings will be lost, that will then have to be made up.

[Douglas Dahl]

Carol C - did you ever receive answers to your questions in this thread?  I'm dealing with a situation where the error (failure to implement election due to misapplication of the 401(a)(17) limit) has been discovered mid-year, and I'm trying to figure out whether the full missed deferral or the 25% QNEC on the missed deferral should count towards the 402(g) limit.  Counting the full missed deferral for purposes of the 402(g) limit seems not to put the participant in the same position had he or she been in had the error not occurred.  It seems more reasonable to me to count only the 25% QNEC for purposes of the 402(g) limit and allow the participant to "make up" the rest of the missed deferrals in subsequent pay periods in the current year.  Thoughts?