How long is too long?

[Guest KaroliHayes]

Here's the situation:

1) An employee signs a deferral election six months in advance of his eligibility date.

2) The personnel department files the election and then fails to put it into effect when he becomes eligible to defer.

3) In 1996 and 1997 the employee receives a statement from the plan showing a Profit Sharing allocation but no elective deferrals or employer matching contributions. He also receives W-2 forms for both years showing no 401(k) deferrals and his pay stubs also indicate no 401(k) deferrals.

3) In October, 1998 the employee finally notices that no deferrals are being taken and asks the personnel department for an explanation. Upon review, personnel advises him that they erred in not placing his 1995 election into effect, and that they will permit him to defer as much as possible with an equivalent match to the legal limit in order to "catch up" the contribution.

4) Employee responds with the threat of a lawsuit.

Is there some point where the responsibility for this shifts to the employee? He did, after all, receive paystubs for 2 1/2 years which clearly indicated no withholding, he received statements of account and w-2 forms for 2 years and didn't notice until the end of the third year.

Is this all the employer's responsibility? What is a reasonable period of time to elapse before the employee shares some of it?

[Alonzo]

The safest solution in this case is to make a QNC equal to the missed deferrals, add earnings that the participant otherwise would have made, and make the match that would have been made. IRS guidance on correction methods (Rev Proc 98-22) indicates that this is the way to go.

However, your employer will regard this solution as totally unfair, since the participant apparently abdicated his responsibilities. So the employer's attorneys need to draft up a letter to the participant indicating that if he has a beef, he needs to go through the plan's claims proceedures before filing a lawsuit. Also, the employee needs to receive the message that the most he'll get out of a lawsuit is a contribution under the plan equal to the safe method contribution described above. He won't get damages. (His attorney will get attorney's fees.) He just might lose.

Did the employee ever get a 401(k) statement, by the way?

[Guest bswift]

that is a tough problem for which there is no easy solution. Practically there are at least two approaches to take and in my mind it may depend on the amount of dollars involved. First you could treat the participant as having been excluded from the plan and correct under the simplified correction procedure that would require the employer to make a qnec equal to the average deferrals for the eligible group plus match plus earnings for the period excluded. The other approach is to tell the employee that while the company initially made a mistake, he had a responsibility to tell the employer that his deferral election was not implemented. On a forward going basis, you can make up the lost deferrals by increasing his deferral election rate, but that the employer is not going to make a contribution to the plan to make up for deferrals that should have been withheld. If the contribution was made it would result in a windfall for the employee who was largely to blame for the mistake. Of course there also may be some middle ground between the two alternatives. You probably already figured out these possibilities, but those are my thoughts.

[Guest Paul McDonald]

Devil's advocate: How clear are the statements provided to the employee? Do they make any disclaimers or make any statements to the effect that the employee is expected to report any discrepancies to human resources within a prescribed period or H.R. will not assume responsibility? Do you really want the IRS and DOL to possibly get involved?

The employee did what he was supposed to do. I see no indication here that the employee did anything wrong. I would not immediately assume that the employee would lose. If the employee were asking this question they would be advised to pressure the plan administrator first and then they could go to the DOL, etc.

I would be careful on recommending the double-up to catch up or go ahead and try to sue me theories. Make sure the rest of the house is in order before just biting the bullet and making the standard correction.

Remember, part of the standard correction process is to put into place procedures to make sure the same type of error does not reoccur.

[Alonzo]

If this were my plan, I'd do the make-up QNC and wash my hands of the situation. That way, the plan would probably qualify for APRSC, and everyone's worries would be over. I don't advocate a get tough approach, and do not believe that it should be recommended. The fees of the professional advisors will probably exceed the contributions that would have to be made by doing things the safe way.

However, you will find, if you get a situation like this, that employers really resent making QNCs in the circumstances we're discussing. There's a mindset that believes, by adopting a 401(k) plan, an employer has passed many of the usual retirement plan responsibilites (including seeing to it that elections are carried out) to the employee. If the employer is going to approach things that way, he'd be well advised to use his claims procedure and consult his attorneys.

[Guest Eric L]

No matter what option (i.e., pay or fight) the employer chooses, they have to recognize they're setting a precedent. As such, the cost of adopting the QNEC approach may go well beyond the cost of making whole this one participant. I'd advise them to seek the advice of counsel before choosing one route or the other. Any CBA they do should factor in the relative cleanliness of the rest of the plan in operation.

Of course, this SHOULD be an isolated incident. As Paul says, they need to make sure adequate procedures and processes are in place to make sure this sort of situation doesn't recur.

[Guest EdwardF]

If the employer had permitted the participant to make up the missed contributions through payroll deductions, would a W-2C be necessary to adjust the taxable income of the prior plan years. Also, in which plan year(s) would the made up contributions be applied to the 402(g) limit.

[This message has been edited by EdwardF (edited 03-11-99).]