Correction of Mistaken Deferrals

[Guest CMC]

A plan failed to prohibit participants from making elective deferrals during the 12-month period following their hardship withdrawals. The safe-harbor correction involves returning the mistaken deferrals. But how do you implement this correction with respect to participants who have already terminated and taken a distribution of their mistaken deferrals?

[RCK]

First, be sure that the plan requires suspension of contributions. That is part of the safe harbor design for Hardships, but is not a general requirement.

If you are self-correcting this, and there no guidance that is directly on point, then I would not do anything for those who have already terminated. The alternative is to issue revised W-2's, and 1099-R's and notify them that part of their distribution if they took it as a rollover is not rollover eligible.

[Guest CMC]

Thanks for your reply.

The plan does require suspension of contributions -- it tracks the safe harbor standard for the needs test.

I'm hoping this will be able to be be self-corrected. At this point, it appears that only one employee made mistaken deferrals prior to January 1, 1999. She is one of the ones who then terminated and took a distribution of her mistaken deferrals. (I don't know whether she took it as a rollover.)

If after further review of the facts this problem appears to be "significant," do you think the fact that this one employee made mistaken deferrals in 1998 (a problem that, if a correction were going to be made, could not be corrected within the 2-year time period for correction of significant defects under SCP (formerly APRSC)) will preclude use of SCP? Or do you think that absent express guidance to the contrary, no problem really exists with respect to this employee (or, alternatively, that a problem may exist but that no correction is required, so that when the correction could be completed is not relevant to whether or not this can be self-corrected)?

Also, any thoughts about the question I posted earlier: If mistaken contributions made by participants who are still in the plan are returned, should investment loses be taken into account? Rev. Proc. 2001-17, Section 6.02(4)(a) suggests corrective allocations and distributions need not be adjusted for losses, but is there a problem with returning to participants less than they deferred given that the plan should have prohibited these deferrals in the first place?

[Linda]

How do you code the 1099-R for the corrective distributions to active participants?