Missed deferral (but not really)

[MoShawn]

Had a strange situation come up recently, and I'm stumped as to how to go about correcting.

EE was deferring 5% pre-tax and 5% Roth. About 2 years ago, EE elected to reduce Roth to 3%. ER accidentally reduced pre-tax to 3%.

ER now wants to correct by making a QNEC for the missing 2% pre-tax deferral. I'm not sure this is the right approach, as the deferrals in total were correct and any new money contributed would be an undue windfall for the participant.

On the other hand, I see where some correction is needed since the participant has lost out on the pre-tax nature of the deferrals for the last 2 years.

[BG5150]

So instead of regular 5% and Roth 3%, they changed it to regular 3% and Roth 5%?

If so, I think you would only have to switch the money from one "bucket" to another. But that would be only if the funds were invested identically all along. Also, proper administration of the basis.

[Peter Gulia]

Was the mistake setting both portions to 3% of pay, or was it setting one portion (but the wrong one) to 3%?

[MoShawn]

BG has it right. The participant wanted 5% pre-tax and 3% Roth, but the employer changed it to 3% pre-tax and 5% Roth.

I understand the source switch, and think that is the most proper way of correcting. What I'm not sure about is what happens on the personal taxes side of things. He presumably reported as Roth a portion of his contributions that should have been pre-tax. (I'm probably thinking too much about this. I've been accused of that in the past.)

[MoShawn]

Any further thoughts on this? The client is determined that the proper correction is to provide to 2% pre-tax that was "missed" and leaving the 2% "extra" Roth alone.

[QDROphile]

One way to look at it is that two mistakes occurred, both involving a failure to implement an election properly. Under EPCRS principles, all failures should be cured. Under EPCRS the "client's" solution is improper in two respects, (i) not correcting the Roth deferrals that were too much, and (ii) not following the prescribed method for correcting missed regular deferrals (the method does NOT prescribe corrective contribution of 100% of the missed deferral). The proposition might be approved by the IRS under VCP, but I think it is quite risky under SCP.

[masteff]

Have they asked the magic question of what does the participant want? The participant is essentially whole, it's really just a classification error of the funds.

Looking at "Future Enhancements" in Rev Proc 2013-12 section 2.05(3), I think it would not be too unreasonable to reclassify the 2% and issue a corrected W-2. But I don't think doing a 2% QNEC is a wrong solution; just more than is what is actually needed.

http://www.irs.gov/pub/irs-drop/rp-13-12.pdf

[BG5150]

I think a 2% QNEC is not necessarily "wrong" in this case, but counterproductive. If you make the QNEC, you will have to "forfeit" the excess money that went to Roth. To me, it's essentially a zero sum game. Otherwise, the participant is getting a windfall.

[Bill Presson]

If the employer wants to "correct" it, that's great. But while I see a small technical issue here, I don't really see how the participant is harmed. Especially if they took 2 years to raise the issue.

[BG5150]

If the employer wants to "correct" it, that's great. But while I see a small technical issue here, I don't really see how the participant is harmed. Especially if they took 2 years to raise the issue.

The participant was "harmed" in that he or she has two years of 2% of income that was taxable rather than pre-tax.

Whether it turns out to be beneficial or not in later years remains to be seen.

[MoShawn]

Well, I finally got the numbers. The total that was missed for the three years was less than $650. As I said, the client determined that they wanted to make the QNEC as a goodwill gesture to the participant and given the small dollars amount involved, we're not inclined to fight them on it.

[Belgarath]

I'd get them to sign off on something saying that they are doing this against your advice, and that if the IRS audits and imposes any penalties, it will be their responsibility, and not yours.

I grant you that this is not a "big deal" - but if the excrement hits the windmill, most clients automatically say, "Who can I blame?"

It is a constant mystery to me why employers pay TPA's to properly administer a plan, then refuse to follow the TPA's advice...

[Peter Gulia]

Just so that I learn something from Belgarath's observation:

If a TPA delivered its advice in writing (which might be an e-mail) and what the plan's accounts show is something other than what the TPA advised, wouldn't the combination of those facts be enough to prove that the TPA is not responsible for the plan administrator's decision?

Or is there (as I suspect) something about relationships between a plan's administrator and its TPA that make it sensible for a TPA to protect itself with not only proof of what advice the TPA delivered but also of the plan administrator's deliberate decision not to follow the advice?

[Belgarath]

I doubt you'll learn anything from my post, and I'd defer to the attorneys out there on the legal ramifications. My observation is based more upon paranoia and practical experience. I've found that once you make them squirm and hold their toes to the fire by some sort of sign-off, they are more inclined to follow your advice. Whether this sign-off actually provides any additional meaningful legal protection is something I can't say.