QNEC for a missed deferral

[fiona1]

I'm curious how others would handle this situation. 1/1 plan year, 401(k) plan. 2011 ADP test failed and refunds were issued in March of 2012.

The employer just now realizes that they forgot to deduct deferrals from 3 participants (NHCE's) during 2011. These 3 participants had elections on file, and were included on the ADP test with 0%.

The employer is going to self correct, and fund a QNEC equal to 50% of the missed deferral (based on the actual elections).

1) Should the 2011 ADP test be reprocessed to include the QNEC to come up with their deferral percentage? If so, then the test will have better results (since it uses the current year testing method) and the HCE's may need to send some of their refunds back to the plan.

2) Assume the 2011 ADP test did NOT include those 3 participants. So not only did the employer forget to deduct, but they weren't included in testing, either. Should the ADP test be reprocessed to include those members - and if so, do you use their QNEC amount to determine their deferral percentage?

There is no guidance that I'm aware of that addresses this....

[ETA Consulting LLC]

1) Should the 2011 ADP test be reprocessed to include the QNEC to come up with their deferral percentage? If so, then the test will have better results (since it uses the current year testing method) and the HCE's may need to send some of their refunds back to the plan.

Remember, it "IS" a QNEC. This means it "may" be included in the ADP test, but doesn't have to. So, you would weigh the benefits of including it against the extra effort in re-running the tests and adjusting the corretive distributions that were already distributed. As it stands now, there isn't an issue.

2) Assume the 2011 ADP test did NOT include those 3 participants. So not only did the employer forget to deduct, but they weren't included in testing, either. Should the ADP test be reprocessed to include those members - and if so, do you use their QNEC amount to determine their deferral percentage?

There is no guidance that I'm aware of that addresses this....

As a rule, the ADP tests should only include amounts deferred. It is optional to include QNECs.

I wouldn't make any additional changes.

Good Luck!

[00hskrgrl]

I believe the answer to your questions may be found in Rev. Rul. 2008-50, Appendix A, Section 5.05(5)(d):

(d) Coordination with correction of other Qualification Failures. The method for correcting the failures described in this section .05(5) does not apply until after the correction of other qualification failures. Thus, for example, if in addition to the failure to implement an employee’s election, the plan also failed the ADP test or ACP test, the correction methods described in section .05(5)(a), (b) or © cannot be used until after correction of the ADP or ACP test failures. For purposes of this section .05(5), in order to determine whether the plan passed the ADP or ACP test the plan may rely on a test performed with respect to those eligible employees who were not impacted by the Plan Sponsor’s failure to implement employee elections and received allocations of employer matching contributions, in accordance with the terms of the plan and may disregard employees whose elections were not properly implemented.

You can re-run the test excuding the 3 impacted by the employer's mistake. If the test still fails by a smaller or wider margin, then correct the refunds issued by either collecting the overpayments (with earnings) or distributing additional refunds (and paying the 10% excise tax for late refunds). Then calculate and deposit the QNEC's for the 3 affected, including missed matching based on their actual elections (not the missed deferral of 50% of elections), adjusting both for earnings.

Also remember to have the employer document what caused the failure and what steps have been taken to ensure it does not recur. Many people forget this final step.

[BG5150]

This is why getting a payroll report or W2's before doing the testing is so valuable. It (w)(sh)ould have been caught before the refunds were issued.

[00hskrgrl]

This means it "may" be included in the ADP test, but doesn't have to. So, you would weigh the benefits of including it against the extra effort in re-running the tests and adjusting the corretive distributions that were already distributed. As it stands now, there isn't an issue.

I agree with ERISAtoolkit on this point - there isn't an issue with how the test has been run. We diverge when it comes to including the QNEC on the test. I believe Rev. Rul. 2008-50 precludes you from doing that when the QNEC is made under SCP. See guidance provided in my previous post.

I recommend first talking with the client to see if they are interesting in re-running the test with the 3 removed to improve the results. Depending on the fees you charge for this service and the affected HCEs' willingness to repay an overpayment, they might decide not to re-run the test. It probably should be their call, since Rev. Rul. indicates that you *may* run the test without the 3, but doesn't say you have to.