Elective Deferrals Never Made

[Randy Watson]

Assume an employee executes and submits a salary deferral agreement, but deferrals are never withheld from his compensation. Doesn't the employee have some responsibility to make sure deferrals are taken out and contributed to the plan? If this failure lasted for a 3 year period, it seems like the employer's liability should be limited to something less than 3 years...perhaps to the first year alone? Help!

[WDIK]

This seems to be an extremely popular topic.

You can find the most recent discussion here.

[Guest mjb]

We have had these discussions multiple times before on this board. Some posters think that the employer is liable to make up all of the contributions and interest because it is an operationa failure of the plan. Others think that it is not a plan failure because the employer never remitted the funds which is not a failure by the plan and the employee should not be unjustly enriched because of his failure to notify the employer/plan that contributions were not withheld. IRS does not define the failure of employer to remit contributions of eligible participant as a plan failure.

You have a particularly eggerious situation in that the employee filed income tax returns for 3 yrs w/out noticing that no elective contributions have been withheld. It is hard to believe that he thought that contributions were being remitted to the plan if his take home pay was not reduced after he made the election and there were no 401k contributions listed on his w-2. If the employer notifies employees to periodically check their pay stubs or withholding statements to confirm that the proper deductions are being withheld from their pay (e.g. spd) then the employee is negligent for not reviewing pay records.

[Randy Watson]

What is really interesting is that this is a 404© plan. The participants received a 404© "notice" and an SPD containing general 404© informataion. So at this point we have about 72 pay stubs that showed no deferrals, the W-2s for 3 years showing no deferrals and no attempt to direct investments even though they were informed that they were responsible for their own investments. I find it hard to believe that these participants have no responsibility in this.

[Guest dbvail]

Hmmmm......as others have said this topic has been the subject of a lot of good thought and technical consideration. But we have not been able to get to a definitive response, or even a concensus.

So here's my observation. CODA is cash or deferred. Either the money gets deferred or it is taken as cash. Either way the employee is whole. If deferred, he is taxed later, if cash, he is taxed now....and as we all know from the Roth analysis this is a dead heat contingent only on tax rates etc.

So either way the employee is whole, perhaps not happy, but whole.

The remaining issue is any matching contributions. I suppose one could argue thatthe employer should be liable for some number of weeks/months due to their lack of payroll controls, but then the burden would be lifted if the employee failed to notify the employer within some reasonable period.

Without clear guidance (and be careful what we ask for) it seems that reason can be allowed in, and any solution that is respectful of the rights and realities of those involved would suffice. No windfalls allowed, he already got his deferrals as cash. The match is negotiable if done so in good faith.

More thoughts are needed, I'm sure.

[Randy Watson]

For those of you who believe the participants have some responsibility in this, how would you suggest making the correction? I think we would start with the participants' deferral agreements and use that percentage instead of the percentage contained in EPCRS for missed opportunities. Just not sure how we attribute responsibility from there.

[austin3515]

I think ECPRS suggests you would correct at a 50% rate. So maybe take half of what they elected and contribute that to the Plan.

[rcline46]

If the employER wants to make a correction, the 50% or 100% of actual election is fine. I don't think this falls under EPCRS in any shape or fashion.

And after, oh lets say 3 months, I don't think it is an employer issue, I think it becomes purely an employee issue. They have to bear responsibilityl here.

[401_4_ever]

If the employER wants to make a correction, the 50% or 100% of actual election is fine. I don't think this falls under EPCRS in any shape or fashion.

And after, oh lets say 3 months, I don't think it is an employer issue, I think it becomes purely an employee issue. They have to bear responsibilityl here.

If you go with 50% or 100% of the election, are you re-doing testing? The benefit of the EPCRS creating the lost oppourtunity cost was to avoid re-doing testing. (50% of their groups ADP rate).

While you may think the employer doesn't have an issue here, there is still an operational failure here. Having idiots for employees is not an excuse for an employer failing to follow the terms of their own plan document.

[rcline46]

As pointed out earlier, finding an operation failure is difficult. The employee was given the opportunity to defer. There IS a failure on the part of the employer to neglect to respond to a request of the employee, but I don't see an operation failure on the part of the plan.

[Randy Watson]

Rcline 46, any reason why you chose 3 months?

It seems like it would be easier to defend the correction method if you used a period of time after the close of the first tax year since you have the distribution of W-2s and the "participant's" filing of their tax return within the next few months.

For those who think the participant has no responsibility, what would you say if this went on for 15 or 20 years? Does that change anything?

[masteff]

Question one: do you actually have the employee's deferral election and it simply wasn't entered properly in the payroll system or is it only the employee's word or copy of an election that you have to go on? Part of this leads to my next question and part of it goes back to your plan documents and whether they explicity state that enrollments/changes are effective when properly submitted to and received by the benefits department.

Question two: did the employee lose out on any match? If so, I'd certainly review making up for lost match using either the employee's election (if you had it in your records and it just wasn't entered) or fully matched rate (if you can prove the employee tried to enroll but can't document his election).

As to how to make the correction from the position that the EE had responsiblity, my last company would have allowed him to write a check and make a one-time after-tax contribution for an amount up to the missed contributions and would then have given him earnings based on a reasonable interest rate (typically our fixed income fund). By giving him earnings, you make him whole on his loss without unjustly enriching him by the company making the contribution on his behalf (he has the money in his pocket so he can either contribute it now or forever hold his peace). The absolute most I'd give him is earnings on the missed contribs w/out requiring him to actually make-up those missed contributions. Since it's a prior year correction, it would typically fall outside of testing.