Missed deferral correction for participants who have terminated

[Belgarath]

Rev. Proc. 2015-28 provides the new reduced correction amount for certain Elective Deferral Failures that extend beyond 3 months, but are corrected within the SCP correction period. However, in order to take advantage of this, technically correct deferrals must begin no later than.... and this isn't possible for a terminated employee.

So just soliciting opinions - would you go ahead and use the reduced 25% QNEC, or would you go with the "old" 50%?

Very small amounts involved - employer didn't withhold on same vacation pay.

[Lou S.]

However, in order to take advantage of this, technically correct deferrals must begin no later than.... and this isn't possible for a terminated employee.

Why not? 3% of $0.00 pay is $0.00 deferral. Am I missing something?

[Belgarath]

I don't understand your response - maybe I'm the one who is missing something.

So, employee has a deferral election in place - pick a number - 5%. Employer, for whatever reason, doesn't withhold the 5% on vacation pay for January through June. July 1, the employee terminates. Error is just now discovered. Excerpt from the Rev. Proc. below. I don't see how, with an employee who terminated employment months ago, that you can satisfy the requirements to be allowed to use the 25% method? I guess what I'm saying is that it appears to me that this isn't available for terminated participants, as you can't can't institute "correct deferrals" (and I interpret that to mean ongoing actual deferrals) of the 5% that was elected. Thoughts?


03 Description of modifications to encourage the early correction of Employee Elective Deferral Failures.

(1) Safe harbor correction method for Employee Elective Deferral Failures that do not exceed three months. This safe harbor correction method creates a rolling correction period for Employee Elective Deferral Failures that do not exceed three months. Under this safe harbor, no QNEC for the missed elective deferrals is required provided that the following conditions are satisfied:

(a) correct deferrals begin no later than the earlier of (i) the first payment of compensation made on or after the three-month period that begins when the failure first occurred for the affected eligible employee or (ii) if the Plan Sponsor was notified of the failure by the affected eligible employee, the first payment of compensation made on or after the last day of the month after the month of notification;

(b) notice of the failure that satisfies specified requirements in new section .05(9)© of Appendix A of Rev. Proc. 2013–12 is given to the affected eligible employee not later than 45 days after the date on which correct deferrals begin; and

© corrective contributions to make up for any missed matching contributions are made in accordance with timing requirements under SCP for significant operational failures (described in section 9.02 of Rev. Proc. 2013–12) and are adjusted for Earnings. See section 9.04 of Rev. Proc. 2013–12.

(2) Safe harbor correction method for Employee Elective Deferral Failures that extend beyond three months but do not extend beyond the SCP correction period for significant failures. This revenue procedure creates a safe harbor correction method for Employee Elective Deferral Failures if the period of failure exceeds three months (or the conditions for the safe harbor correction method described in section 3.02 or 3.03(1) are not met by the Plan Sponsor). This safe harbor correction would permit the Plan Sponsor to make a corrective contribution equal to 25% of the missed deferrals (25% QNEC) in lieu of the higher QNEC required in sections .05(2)(b) and .05(5)(a) of Appendix A and section .02(1)(B) of Appendix B to Rev. Proc. 2013–12. In order to use this safe harbor correction, the Plan Sponsor must satisfy the following conditions:

(a) correct deferrals begin no later than the earlier of (i) 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 (ii) if the Plan Sponsor was notified of the failure by the affected eligible employee, the first payment of compensation made on or after the last day of the month after the month of notification;

(b) notice of the failure that satisfies specified requirements in new section .05(9)© of Appendix A of Rev. Proc. 2013–12 is given to the affected eligible employee not later than 45 days after the date on which correct deferrals begin; and

© corrective contributions (including the 25% QNEC and employer contributions to make up for any missed matching contributions) are made in accordance with timing requirements under SCP for significant operational failures (described in section 9.02 of Rev. Proc. 2013–12) and are adjusted for Earnings. See section 9.04 of Rev. Proc. 2013–12.

[SadieJane]

Anyone have any further thoughts / developments on this topic? I, too, have heard the argument that if the affected employee terminates before three months is up from when the error began, the 'no-QNEC-required' correction should still be available because as of the correction deadline, the correct deferral of 0% is implemented.

[EBECatty]

I can't say I have heard anything definitive one way or the other. I have taken the position you mention, albeit not in front of the IRS, to correct missed deferrals for terminated employees. Seems they would be hard pressed to argue you haven't fully corrected when there is nothing left to correct.

[John Feldt ERPA CPC QPA]

If they are not due any contribution because the QNEC is zero and they are not owed any match for deferrals that would have occurred, then the only piece left to satisfy the requirement of the Revenue Procedure is to give the notice saying you are correcting the deferrals. Give out the notice and if they have any future compensation due that can have deferrals withheld, apply the correct deferral election.

edited to remove what was an ill-conceived attempt at describing how that notice could be worded.

[SadieJane]

That was uncalled for. By definition, this correction is available only if the failure has lasted three months or less. In practice, this is typically an extra payroll cycle to get a new employee's deferral set up or an employer turning off deferrals when it is notified of a termination, with one payroll cycle to yet to pay for that employee. We're just trying to discuss how to deal with a gap in the IRS guidance.

[John Feldt ERPA CPC QPA]

Then give the notice in order to comply with the Revenue Procedure. If they are owed no extra dollars, you have now complied the last requirement needed to qualify for the zero dollar QNEC. Assuming no match was also missed.

[RatherBeGolfing]

Anyone have any further thoughts / developments on this topic? I, too, have heard the argument that if the affected employee terminates before three months is up from when the error began, the 'no-QNEC-required' correction should still be available because as of the correction deadline, the correct deferral of 0% is implemented.

I'm not sure why you are treating the employer as having implemented the 0% deferral just because the employee left. The employer never actually implemented deferrals for the employee, period. An employee can't elect to have deferrals taken out of pay he/she doesn't get (or elect to have 0% deferred for that matter), so how does it make sense to call that a 0% deferral implemented by the employer?

[Adi]

Old thread, but the 401k Plan Fix It Guide address OP's question:

Example 4:
Assume the same set of facts, except that one of the XYZ’s excluded employees terminated in March of 2016. Then none of the special safe harbors in Appendix A.05(8) or .05(9) would be applicable to the terminated employee as the conditions discussed in Rev. Proc.  2016-51 can’t be met as the employee is no longer employed by XYZ at the time of correction. Therefore, the lost opportunity cost for the missed deferrals would be 50% of the missed deferral amounts for this employee. Adjust for earnings through the date of correction.

The concepts relating to a reduced QNEC for missed deferrals may also be applied to failures involving a failure to implement a 401(k) plan’s automatic enrollment/escalation features or a failure to properly implement a participant’s written salary reduction election.

https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-eligible-employees-were-not-given-the-opportunity-to-make-an-elective-deferral-election-excluding-eligible-employees

 

[John Feldt ERPA CPC QPA]

Is that new? It states it was updated January 2018. I wonder which conditions they are saying can't be met. I have heard ERISA attorneys suggest that perhaps it would be sufficient to provide the notice and have it state that to make up for the missed deferrals, they save more outside the plan since they are no longer employees. The IRS website (unofficial guidance, I know) is indicating that type of notice is not an option?

[Adi]

I'm not sure how recently this was added, and agree that it's not entirely clear which requirement can't be met under the example I posted.  That said, in another example, additional clarification is provided:

https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-eligible-employees-were-not-given-the-opportunity-to-make-an-elective-deferral-election-excluding-eligible-employees

Generally, if you didn't give an employee the opportunity to make elective deferrals to a 401(k) plan, you must make a qualified nonelective contribution to the plan for the employee. This contribution must compensate for the missed deferral opportunity. The corrective qualified nonelective contribution (QNEC) is an employer contribution that's intended to replace the lost opportunity to a participant who wasn't permitted to make elective deferrals.The QNEC must be 100% vested and subject to the same distribution restrictions as elective deferrals.

The amount of the QNEC is equal to 50% of the employee’s missed deferral determined by multiplying the actual deferral percentage for the employee’s group (HCE or NHCE) in the plan for the year of exclusion by the employee’s compensation for that year.

Other IRS safe harbor correction methods may be acceptable to fix this mistake. For failures found and fixed promptly, plan sponsors have the option to reduce the corrective QNEC contribution for the lost opportunity cost from 50% of the missed deferral to 25% under the following conditions:

• The excluded employee must be currently employed by the employer at the time of correction
• The period of failure exceeds three months
• Correct deferrals finally begin by the first payment of compensation made on or after the earlier of:
  • The last day of the second plan year after the plan year in which the failure first began for the affected employee, or the last day of the month after the month the affected eligible employee first notified the plan sponsor; and
  • Within 45 days of being given the opportunity to make salary reduction contributions (or the commencement of auto-enrollment contributions), the affected participant must receive a special notice. See Appendix A.05(9) discussed in Rev. Proc. 2016-51 for details as to the specific content that must be in this notice. If the participant terminates employment before the notice is provided, then this requirement has not been met.

 

[legort69]

So does the community agree that  under RB 2019-19, where there is a failure to auto-enroll EE before the 5500 is filed for the year, if that EE terminates during this period and  prior to discovery of the failure then correction requires a 50% QNEC and full match.  

Whereas, if the EE did not terminate and a notice was provided timely, then only the missed match + gains is required.

Amazing that the RB provides examples but not in this scenario for termed EES within the 'grace period'.