correction for failure to suspend deferrals after hardship

[pmacduff]

ok - I have the code section about stopping deferral contributions for 6 months after a hardship withdrawal (Reg. 1.401(k)-1(d)(3)(iv)(E)(2)).

A plan fails to stop contributions for one participant who has taken a hardship withdrawal.

Can I assume one correction would be to return those contributions to the participant?

Is there information for self-correction of this error? I went through the 401(k) Fix-It guide as well as the SCP info on the IRS site but could not find this situation. (The hardship related errors & corrections that I found were more for allowing hardships when not stated in the Plan.)

thank you in advance.

[Tom Poje]

The comments I found years ago were:

1999 ASPPA Conference Q and A
46. A participant took a 401k hardship distribution pursuant to the hardship safe harbor rules, but was allowed to continue making 401k deferral contributions in violation of the 12-month suspension rule. What are the possible methods of correcting this error under APRSC?
A. Start a full 12-month suspension when the error is discovered?
B. Distribute impermissible deferrals and earnings?
C. Return deferrals and suspend for balance of original 12-month period?
• IRS response; Starting a new 12-month period doesn't meet the rules.
• Deferrals (and match, if applicable) should be forfeited and the balance of the 12-month suspension should be applied.
Of course, the employee should be made whole outside of the plan (i.e., no distribution from the plan to the employee)
.....................
8/10/2007 Benefits Link posting
We have submitted a VCP to the IRS on this very issue. Initially, we proposed to take out the contributions that should not have been made plus earnings and this was approved. In attempting to implement this, however, we found that most of the affected participants did not have sufficient amounts in the money types in question (because of subsequent loans and/or withdrawals) to make this an unworkable solution. We went back to the IRS and they proposed a prospective suspension. The problem was that a number of years had elapsed between the time the amounts were improperly contributed, the first compliance statement was issued and then the second VCP request was submitted and resolved and a final compliance statement issued, that the participants who were impacted complained that the prospective suspension would be coming when they earned a much higher rate of pay. The bottom line is, if you are consider the refund method, take a look to see if there would be sufficient money in the participants' accounts to effect the refund. If not, then use the prospective suspension.
(Note: wouldn’t try it other than under VCP)

[pmacduff]

Thank you Tom. I found the attached from 2013. So using a return of deferrals as a possible correction method seems reasonable if the participant has sufficient funds.

Suspension correction.pdf

[Tom Poje]

so really no different (except the fact back in 1999 the suspension was 12 months (the rules back then) - of course the regulations changed that to 6 months instead of 12)

[BG5150]

It comes down to basic EPCRS principles: we have an operational failure, and we need to put the plan (and participant) in the position they would have been had the error not occurred. To me, it's an excess allocation of deferrals, and can be distributed to the participant (with earnings).

[pmacduff]

There is another difference though, Tom, in the part of the IRS response back in 1999 (paraphrasing) 'forfeit the deferrals and match and make the employee whole outside of the Plan'. I don't see that as a better method than giving the $$ directly back to the participant from the plan account. What if the Sponsor never made the participant whole outside the Plan?

Anyway - love the take BG - I would agree it IS an excess allocation of deferrals and should be handled as such.

[Tom Poje]

agree. I think the IRS response in 1999 is a hard line response "Once $ are in a plan you can't take them out", but since then (especially with self-correction) the IRS has seemed to say "If you aren't entitled to it, get it out and put the plan in a position as if the error didn't occur."