Ineligible 457(b) Governmental Plan Participant

[oldman]

A governmental 457(b) plan covers only full-time employees. A part-time employee has contributed to the plan since 2008. To remedy this operation failure, can the plan distribute the elective deferrals plus earnings back to the employee? In addition, is the plan sponsor responsible for covering any loss on the contributions made to the plan?

[30Rock]

Oldman

I am copying an article from McKay Hochman on how to correct for ineligible participants, based on 401k plan rules. You can probably use the same reasoning on your 457 plan however it looks like only option 1 and 3 are approved correction methods.

Option 3 will not be available since the 457b does not have forfeitures since most likely there is no vesting schedule or employer contributions. I would push for option 1. Option 2 would require direction from the plan and their legal counsel.

______________________________

Correction of Elective Deferral Contribution by Ineligible Employee

Rev. 06/12/08, E-mail Alert 2008-8, 05/26/09, E-mail Alert 2009-7

Elective Deferral Contribution Made by an Ineligible Employee

Correction The formal guidance that exists is in EPCRS (see option 1). Generally, EGTRRA preapproved prototype defined contribution plan documents now provide that the employer shall make any such correction regarding the employee's eligibility under one of the IRS approved correction programs. Although the GUST preapproved prototype documents had the IRS approval to use other methods, such as distributing the ineligible deferrals, the IRS has not approved these methods as part of the EGTRRA document, but rather refers the employer to the IRS approved correction methods. Employers adopting the EGTRRA prototype defined contribution plan document will no longer find options 2 and 3 below as plan provisions, although option 3 would appear to meet the EPCRS self-correction rules.

1. EPCRS procedure to retroactively amend the plan to include such an employee.

2. Distribute the elective deferrals and the associated earnings to the individual who made them in the plan year in which the discovery is

made. This option should only be used if the document provides for it. Not available once the employer adopts the EGTRRA document.

3. Forfeit from the ineligible employee's account. Allocate the forfeiture as stated in the plan document. Reimburse the employee and adjust for earnings.

--------------------------------------------------------------------------------

Option 1, EPCRS revenue procedure 2008-50 rules for retroactively amending the plan (from Appendix B, Section 2.07(3))[/b][/b]

"(3) Early Inclusion of Otherwise Eligible Employee Failure. (a) Plan Amendment Correction Method. The Operational Failure of including an otherwise eligible employee in the plan who either (i) has not completed the plan's minimum age or service requirements, or (ii) has completed the plan's minimum age or service requirements but became a participant in the plan on a date earlier than the applicable entry date, may be corrected by using the plan amendment correction method set forth in this paragraph. The plan is amended retroactively to change the eligibility or entry date provisions to provide for the inclusion of the ineligible employee to reflect the plan's actual operations. The amendment may change the eligibility or entry date provisions with respect to only those ineligible employees that were wrongly included, and only to those ineligible employees, provided (i) the amendment satisfies §401(a) at the time it is adopted, (ii) the amendment would have satisfied §401(a) had the amendment been adopted at the earlier time when it is effective, and (iii) the employees affected by the amendment are predominantly nonhighly compensated employees.

(b) Example

Example 27

Employer L maintains a 401(k) plan applicable to all its employees who have at least six months of service. The plan is a calendar year plan. The plan provides that Employer L will make matching contributions based upon an employee's salary reduction contributions. In 2007, it is discovered that all four employees who were hired by Employer L in 2006 were permitted to make salary reduction contributions to the plan effective with the first weekly paycheck after they were employed. Three of the four employees are nonhighly compensated. Employer L matched these employees' salary reduction contributions in accordance with the plan's matching contribution formula. Employer L calculates the ADP and ACP tests for 2006 (taking into account the salary reduction and matching contributions that were made for these employees) and determines that the tests were satisfied.

Correction:

Employer L corrects the failure under SCP by adopting a plan amendment, effective for employees hired on or after January 1, 2006, to provide that there is no service eligibility requirement under the plan and submitting the amendment to the Service for a determination letter."

Option 2

Not available on EGTRRA plan document Option 3

Although not in the EGTRRA document, this method would appear to be fine under EPCRS self-correction guidance.

Taxable Year Excess and earnings should be taxed in year returned to employee.

Excess and earnings should be included in payroll and included in the W-2 for the year of reimbursement.

Impact on Participant /

Employer Participant’s W-2 had been reduced by the elective deferral and the refund of the elective deferral is reported on a 1099R.

Participant’s W-2 will be affected.

If Not Timely

Corrected If not corrected within 12 months of the contribution, file under VCP or self-correct under SCP.

If not corrected within 12 months of the contribution, file under VCP or self-correct under SCP.

Tax Reporting /

Notice 1099R issued for affected participant(s).

Correct W-2 for affected participant(s).

Other Tests If the ineligible participant's deferrals had been included in the ADP test, the test would have to be done over without those deferrals.

If the ineligible participant's deferrals had been included in the ADP test, the test would have to be done over without those deferrals.

To learn more, call 1-973-492-1880 or e-mail info@mhco.com.

© 2010, McKay Hochman Co., Inc. All rights reserved.

[oldman]

Thanks. At least there are viable options for the plan sponsor to consider.