Plan Fails to Implement Suspension Following Hardship Withdrawal

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Employer M maintains a 401(k) plan for its employees. Under the plan, an employee can request an in-service distribution upon a showing of financial hardship, which is defined by reference to the safe harbor standards outlined in the IRS regulations. Employee A requested a hardship withdrawal, which was granted. However, the plan failed to implement the 6-month suspension period required under the regulations. How should the plan correct this error? (1) Refund all deferrals for the period in which the suspension would have otherwise applied and forfeit any related matching contributions and earnings during what should have been the suspension period? or (2) Impose a prospective 6-month suspension period?