Failure to suspend deferrals after hardship

[Guest Rebel TPA]

Client has a participant who took a hardship deferral in late January 2010. All 401(k) deposits for the participant were made between February and July, so there is an excellent chance that all of the deferrals are tainted. The client calculates match on a payroll basis, so the "ineligible" deferrals generated match as well. The participant terminated employment and has taken distribution of the entire account balance. The failure to suspend deferrals wasn't discovered until 2011.

I have a pretty good handle on the typical correction of deferrals and match when deferrals aren't suspended - distribute the deferrals and related earnings under EPCRS and forfeit the related match - but I cannot find any documentation concerning the treatment for purposes of testing. I have an ERISA attorney telling me that both the 401(k) and match must be included in ADP/ACP testing and are considered annual additions for 415 purposes. This doesn't seem appropriate to me, but I cannot find anything that specifically addresses the matter.

Does anyone know if this has been addressed anywhere in the regs?

[Guest Sieve]

As an Excess Allocation, correction is under EPCRS 6.06(2), which says: "For qualification purposes, an Excess Allocation that is corrected pursuant to this paragraph is disregarded for purposes of . . . § 415, the actual deferral percentage test of § 401(k)(3), and the actual contribution percentage test of § 401(m)(2)." There are certain instances when certain excesses are included in ADP/ACP & 415 (such as some 402(g) excess deferrals, even if returned--Treas. Reg. Section 1.402(g)-1(e)(1)(ii)), but, in this case, I think your attorney is incorrect (unless I'm missing something completely).

[Guest Rebel TPA]

The attorney mentioned more than once that the amounts would show up in testing unless the correction was made in the same year. Does that make a difference? I don't see any such timing requirement in the provisions of EPCRS 6.06(2) that you cited.

[Guest Sieve]

Well, I don't know if I agree with the "same year correction" approach, but, on a practical level, catching/correcting the error long after the ADP/ACP tests have been performed and appropriately corrected does mean that those amounts were, in fact, taken into account for testing. But, since you've caught it in the year in which the ADP/ACP tests are being performed, I would say that correction by year-end through EPCRS would be sufficient (and the test is then performed based on the returned deferrals and forfeited matches).

But, then, I'm not the attorney you're paying to make the correction.