plan didn't allow participants to defer bonuses

[mariemonroe]

401(k) plan permits deferral of compensation.

"Compensation" is defined to include salary and bonuses.

Plan permits participants to defer salary, but not bonuses.

Plan realizes error and, in 2006, allows participants to defer bonuses. Out of 400 or so participants, only 15 chose to defer bonuses.

The error has gone on for more than 2 years so SCP in not available.

Does anyone have any ideas as to how to fix?

[Just Me]

File VCP. Employer assumes all deferring participants would have also deferred from bonuses, and makes corrective contribution plus earnings (and match if applicable). Likely can get OK from IRS to contribute 1/2 of the deferral correction under VCP.

[Trekker]

I have a slightly different question on a similar situation.

Participants properly completed an elective deferral form to have a percentage withheld from Compensation, which, by plan definition, includes bonuses. There is also a matching contribution.

Deferrals were not withheld from bonuses for plan years 2005 and 2006. Related matches were not made.

Employer will calculate what should have been withheld and deposit the full amount. Since this is not a "missed opportunity" situation, we don't want to run the risk of using 50% as permitted under RP 2006-27. Appropriate matches will be made and earnings will be added.

TWO QUESTIONS:

(1) Is this self-correctible without filing a VCP since we're within two years of the failure?

(2) Must the ADP and ACP test be recalculated for those years? The correction involves both HCE and Non-HCE.

Any help is appreciated.

[ak2ary]

Let me play Devil's Advocate here

Did the plan prevent the employee from making a contribution that is permitted under the terms of the plan? For instance, assume a plan defines "compensation" for all purposes as W-2 compensation plus deferrals. That Compensation includes things like imputed life coverage. It is impossible to defer "FROM" imputed life coverage since there is no money from which to defer. But if the plan does not have a limit on deferrals such as 6% of Compensation, all employees are permitted to defer as much as they wish...that is the fact that the deferral did not come directly from the paycheck onto which the compensation was imputed does not mean that the plan improperly limited deferrals or had any violation whatsoever.

Assume in a calendar year the company gives bonuses in February. It does not take any deferrals from that paycheck..but if the plan does not have limit on deferrals, or if includes the amount of the bonus in the determination of the deferral limit, no participant is limited to a deferral less than that allowed by the plan. (with the possible exception of those who would have contributed more than their total pay less bonuses)

Consider a plan that defines Comp as total comp but provides on its salary withholding form that deferrals will be withheld from regular paychecks only..again no participant is hurt if they are able to defer the full amount provided for in the plan.

I have twice had plans where the solutions proposed above were suggested by another firm.(or worse, the ADP of the NHCE group was applied to the bonus and was to be contributed for all NHCEs ...even those who elected no deferrals) in situations where no one was harmed. One has to be careful to look at the impact of differences between the plans definition of pay and operation to see if anyone was harmed to determine if you have an operational defect.

Obviously where the deferral is lomoted to a percentage of pay and that limit is based on the wrong pay, or the match is calculated on the wrong pay you have an operational defect...but not always with the deferral

[Trekker]

ak2ary: Thanks for taking the time to offer your response. We will consider this angle and see if it offers a good resolution.