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Employee contributions made to wrong Plan


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Employer has two plans.  HCEs are supposed to participate in the 403(b) plan.  NHCEs are supposed to participate in the 401(k) plan.  Each year, HCE or NHCE status is determined for the following year, and the person is supposed to be put into the correct plan accordingly.

However, errors have been made in some instances, in both directions.  Thus, for example, HCEs have contributed to the 401(k) plan, and NHCEs have contributed to the 403(b) plan.  Obviously, this violates the terms of both plans.

Does anyone have any experience as to the corrections IRS might be willing to accept in these circumstances?  What we'd like to do is to treat this as a mistake of fact, withdraw the incorrectly contributed amounts from each plan and contribute it to the other plan.

However, by the literal terms of the IRS Fix It Guides, the HCEs have been impermissibly denied the right to make contributions to the 403(b), and the NHCEs have been impermissibly denied the right to make contributions to the 401(k), which would require QNECs in both cases.  And then the HCEs have made impermissible contributions to the 401(k) and the NHCEs have made impermissible contributions to the 403(b), all of which would have to be disgorged.  

All of that just seems to be excessive, given that no one has been denied the right to make contributions.  And the investments of the two plans are the same, so no one has lost out in that area, either.

What has been your experience?  Will the IRS allow for a reasonable correction, or does it insist on following the technical terms of the Fix It Guides in this situation?

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Were the deferral elections completed for the correct plans, and employer then just sent funds to the incorrect plans? Or were they given deferral elections for the improper plans? If the former, I'd consider it a mistake of fact. If the latter, then I'm not so sure,  I've had no direct experience with that specific situation.  Under the facts and circumstances, is this either insignificant or significant within the SCP period? 

If you have to (or choose to) go through VCP, I'd certainly try for a reasonable fix - in that respect, I've found the IRS to generally be very reasonable. I personally wouldn't get too hung up on the fix-it guides - they are handy, but by no means the only allowable solutions. Possibly some re-do of ADP/ACP testing might be necessary - results could be very different. I'll be interested to see if anyone has direct experience with an identical situation - maybe it is more common than I think.

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51 minutes ago, Belgarath said:

If you have to (or choose to) go through VCP, I'd certainly try for a reasonable fix - in that respect, I've found the IRS to generally be very reasonable. I personally wouldn't get too hung up on the fix-it guides - they are handy, but by no means the only allowable solutions. Possibly some re-do of ADP/ACP testing might be necessary - results could be very different. I'll be interested to see if anyone has direct experience with an identical situation - maybe it is more common than I think.

I agree. I've had several "interesting" situations and have found the IRS generally reasonable where the proposed correction makes sense and you can demonstrate the underlying error did not arise of out abuse/bad faith. Once you get through the 18+ month wait, that is. 

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When I was inside counsel to a big recordkeeper, I saw this problem often, especially with healthcare employers.

 

If the § 403(b) and § 401(k) plans’ investment alternatives are identical (or nearly so) and one recordkeeper serves both plans, there might be a straightforward correction.

 

Even if the facts allow an ERISA § 403(c)(2) mistake-of-fact return to the employer, it can be unhappy because it’s work—often four layers of computations and reprocessing—and the employer can be exposed to restoring investment breakages that resulted from the employer’s mistake.

 

Instead, the recordkeeper corrects both plans’ records (including for each affected individual account) so every account and subaccount shows the correct number of investment fund shares.  There is no payment of money, only corrections of records of beneficial ownership of investment fund shares.  (I assume neither plan had shareholder-of-record ownership.)  Done methodically and thoroughly, all records will remain in perfect balance.

 

Employers instructed these records changes without seeking any IRS approval.

 

Of those that later attracted attention (in the 1990s there was a wave of IRS audits of big healthcare systems), the IRS accepted what was done.  For most, the IRS examiner without hesitation accepted what was done.  For a few, I persuaded the examiner or supervisor that an employee could not have an elective deferral under a plan to the extent she was ineligible to so participate, and that the employer could not have made a contribution allocable to what could not have been an elective deferral.

 

Under equity law, a person or entity does not keep property if it in good conscience belongs to another.

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