Ineligible employee allowed to defer too soon

[Pammie57]

If a client let an ineligible employee Defer- is the accepted correction to return the deferral plus earnings or do they forfeit the def and match-and make them whole outside the plan?

[Tom Poje]

while their may be other methods of correcting the problem, the one method clearly found under EPCRS Appendix B section 2.07(3)
(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 plan 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. For a defined benefit plan, a contribution may have to be made to the plan for a correction that is accomplished through a plan amendment if the plan is subject to the requirements of § 436© at the time of the amendment, as described in section 6.02(4)(e)(ii).
(b) Example.
Example 27:
Employer L maintains a § 401(k) plan applicable to all of 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.

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sorry, I can't recall if the latest updated EPCRS revisions that just came out indicated determination letters were still required or not.

[Pammie57]

Thanks Tom - I had read something about doing the amendment, but does that create 2 sets of eligibility requirements? does that change coverage test/ ADP test or anything else I need to know about?

[Tom Poje]

my understanding is you would treat (or at least could treat) such people as otherwise excludables, in which case it probably wouldn't change testing.

If the only employees involved were NHCEs then that wouldn't be a problem, item (iii) above notes that those affected by the amendment must be predominantly NHCEs. so if, somehow it was only an HCE (which would almost have to be an owner because of the look back rule) then it already smells bad!

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I should have pointed out from above, the amendment method is clearly allowed under the self correction method.

so if you follow those procedures you have guidance if the plan was ever audited, etc. and it avoids other issues.

some folks lean toward returning the $ - there are no examples in EPCRS, but even under EPCRS the rules say to put the plan in a position as if the error hadn't occurred. but then do you have to issue 1099s and other things that aren't real clear.