Plan Sponsor For Years Over Contributed to 401(k)

[Cardscrazy]

I just joined a great company as a 401(k) administrator and immediately saw that their annual 401(k) match calculation formula of 25% of first 6% had two failures (1) failed to cap wages at the the 401(a)17 compensation limit and (2) failed to cap the match computation based on the first 6% of wages. 

They essentially took 25% of deferrals across the board as the company match.  $750K overpaid match in 2018 by my calc.  Match was correct for those whose effective deferral rate was 6% or less (400 EEs).  The match on 600 EEs with higher deferrals than 6% were all overpaid.  It is an audited Plan; been around for many years making this mistake.

I can see that a VCP filing will be needed.  I took a look at Rev Proc 2018-52, 2.07(1)(b), Example 25 and I don't see how a retroactive amendment will work when it's not just a 401(a)(17) failure but compounding computational errors.  The company is successful and expensed and shelled out way more than it should have.  The company I'm sure they would be more willing to fix going forward than pull funds out of accounts.  I'm sure we'd offer to pull out money from executives at a certain level and above if that's what it takes.  Has anyone seen such a longstanding mistake and what would be a typical IRS response to the company  be with such a huge overpayment?  How far back would they make the correction go?  What negotiation can be done?   Haven't informed ERISA counsel (I'd fire the auditor if it were my decision) yet only working my way up the chain of command at this point.  I am a new hire afterall.  I just want to have some idea of what the company is facing here before I push harder.  Thank you!!

https://www.irs.gov/retirement-plans/fixing-common-plan-mistakes-using-a-plan-amendment-for-correction-in-the-self-correction-program

[duckthing]

Does the plan document specify the matching formula, or does it just say the match is discretionary? How many years are we talking about here, 5ish or 20ish?

I can't speak to the questions about IRS response and possible corrections/sanctions, but I'd recommend taking a look at the just-released Rev Proc 2019-19, which expanded the class of operational failures that can be corrected via retroactive plan amendment. It's possible some of your problems (matched deferrals not capped at 6% of compensation) can be fixed this way under the new rules. Of course the existing correction under SCP for allocations based on compensation that exceeded the 401(a)(17) limit is still available. Unfortunately there is still a time limit for fixing significant errors via SCP so it sounds like VCP would still be needed for some years, assuming you determine these failures are significant.

It sounds like there are failures at multiple levels here, from payroll up to the auditor. The fact that the auditors' samples didn't catch an issue that occurred for 60% of the participants is worrying. Somebody with more IRS experience than I have might be able to speak to the possible benefits of an anonymous VCP filing and/or having a separate auditor review the years in question prior to the filing.

[justanotheradmin]

I agree with duckthing. 

The match not being capped at 6% (if that's the cap in the document) is easily fixable, I would have a hard time seeing the IRS not approving a retroactive corrective amendment, especially in light of the update to retroactive amendments in Rev Proc 2019-19. 

The second error, the failure to limit considered compensation, is a bit trickier. I would probably suggest in the VCP submission asking if it can be left alone for earlier year (such as 2017 and earlier), and just corrected according to EPCRS principals for 2018 and future years. Unless there is a top-paid group election that limits the HCE count, anyone over the comp limit affected by this failure is likely HCE, so it is hard to justify leaving the match as is for those earlier years when only HCE's benefit from it. If you have ERISA counsel available, at least this error should be run by them to see what they say. 

I would also want to know what the auditor will say. Some auditors will not provide an unqualified opinion if errors are fixed in certain ways. 

It doesn't provide protection while under review, but if the employer is reticent to go through VCP anonymous submission is an option. 

Also, if I was a new employee, I might start with the auditor, and see what version of the plan document they are working from. Is it possible they have a different version with a more flexible match formula in it? Sometimes the document the client has and the one the auditor has has diverged because the auditor hasn't been provided copies of amendments or updates. 

[Cardscrazy]

Thank you duckthing and justanotheradmin.  It is a fully discretionary formula in the plan.  You helped by giving me the idea that we might be able to bifurcate the two errors and mix and match the solution with the IRS to fix the two errors.  I'll keep reviewing what you both wrote.  Thank you for your time!!

[justanotheradmin]

You mention it's a fully discretionary formula in the plan document - does that mean there is no cap at 6% for deferrals considered? 

And that the employer was just desiring to cap the matched deferrals at 6%, but the requirement is not actually in the document?

If there is no cap in the document - the first error doesn't exist. If I as the employer meant to contribute 10%, but later on forgot and contributed 12%, well guess what, the 12% sticks. 

[Cardscrazy]

Thank you all.  What you wrote above got me thinking and it was confirmed later in a private message to me (that I can't seem to find anymore and didn't even know could be sent) that when my employer told employees (and the audit report reads the same) that the discretionary match was 25% of contributions, up to 6% of eligible compensation, what they really contributed was 25% of contributions.  And so if the plan was retroactively amended to reflect that the match formula from 2003 to 2017 was actually 25% of contributions then at least problem #2 is fixed, right?  But what about the first problem in which compensation was not capped at the 401(a)(17) wage e.g. $275K?  Does it even matter since a 25% of contributions match formula has nothing to do with wages?  This is what I think you, justanotheradmin, and that private person are driving at.  Am I understanding what you are saying?  They complied with the 402(g) and 415 limits btw.  Thanks again!

[Jim Chad]

NO.  because if you do not cap compensation properly, the IRS would say that you have a discriminator match.  IMNTBHO

[Bird]

If the match is in fact discretionary as a percentage of contributions, I don't see where compensation comes in.

[chc93]

56 minutes ago, Bird said:

If the match is in fact discretionary as a percentage of contributions, I don't see where compensation comes in.

I think I agree.  And the OP did say that they complied with 402(g) and 415.  So unless there are other contributions or compliance issues that depend on compensation, I don't see a problem.

Is there anything else that depends on compensation that you are concerned about not capping to 401(a)(17)...

[Cardscrazy]

Thank you all again for your comments.  I think that I have a much better understanding after reading all your comments: 

25% of the deferral is a permissible match formula and we should be able to retroactively correct via amendment for the interpretation error that the company made when it initially said 25% of contributions, up to 6% of eligible wages; but, then went and ignored the 6% wage cap in calculating the match.  

Also, that there is probably no 401(a)(17) issue either because a match formula that is 25% of contributions doesn't need to be capped by wages, when 402(g) and 415 will cap it instead.  It might be a testing issue, but I'll let the TPA worry about that.

And finally, we'll see if the company wants to save $750K a year by keeping the 6% wage cap and doing it right or if they will just drop the whole 6% thing and go with a flat 25% of contributions formula.  We will see.

Thank you again!

[BG5150]

If this is a corporation, doesn't the ER have to declare the discretionary match formula each year, similar to a profit sharing contribution?

[Cardscrazy]

Thank you!  Yes, the ER did declare an annual discretionary match formula and it was: “25% match of contributions, up to 6% of eligible wages.”  What they actually did in practice was match 25% of contributions, but (I neglected to add this above) no participant was allowed to receive a match equal to an amount greater than 6% of eligible wages.  Examples:

25% of contributions: 1013 participants	Match <= 6% of eligible wages: 3 participants
Wage: $1,100,000; deferral: $24,500	Wage: $50,000; deferral: $15,000
Match 25% of $24,500 = $6,125 Match	Match 25% of $15,000 = $3,750 > 6% of $50,000
	Adj match = $50,000 x 6% = $3,000
Wage: $100,000; deferral: $20,000
Match 25% of $20,000 = $5,000 Match

The plan document (an adoption agreement) was discretionary (i.e., silent as to the match formula).  The above practice of providing a match of 25% of all deferrals, while capping the match off at 6% of eligible wages, was done consistently through the years.

It was explained to me by an adviser that given that the Plan Administrator has the authority to interpret the terms of the plan, the above interpretation, while not be a conventional interpretation of the “25% match, up to 6% of wages” formula, could be deemed a reasonable interpretation, agree? 

I was advised that the IRS could say that "as long as the interpretation is not arbitrary and capricious", then there won't be a challenge, meaning there’s no real problem here – and nothing to change?  The cap off of a match that exceeds 6% of wages is okay to everyone?

In my mind, due to the awkwardness of the company’s interpretation of “25% of contributions, up to 6% of wages” compared to the typical understanding of such a stated formula, I would think the company would at least change the way they express their match formula going forward, assuming such a formula that caps off the match at 6% of wages is a permissible match formula since it only impacts NHCEs.  Due to the minimal cost, I’d suggest they blow off capping of the match. 

Also, to avoid any audit issue, I’d still recommend some sort of correction be employed.  If a VCP is not warranted, maybe an SCP be employed with a retroactive amendment under Rev. Proc. 2019-19 expressing what the actual match formula used in the past was based on plan administrator interpretation, while leaving the future match formula completely discretionary.  Not sure SCP would be allowed. Maybe a VCP and pay in the 6% cutoff back to those NHCEs.  Any ideas?

Any comment on the “cap-off of the match at 6% of wages” as being a legitimate part of the formula?  Did I make a mountain out of a molehill?  Thank you all again!

[justanotheradmin]

So if I understand this correctly, the only affect group is someone who deferred more than 24%?

Instead of a match of 25% of the deferral amount, the match is capped at 6% of pay. 

As other have mentioned its no longer a compensation issue. Someone who deferred the maximum $24,500 in 2018 at most would have a match of 25% of that, which is  $6,125. 

6% of $275,000 is $16,500. Their match ends up being limited because of their deferral, NOT because of their compensation. 

If the plan document was silent (and ACP passes)- then no retroactive corrective amendment is needed. I would say they should do a quick write up perhaps in a format geared toward what a SCP memo would contain, document it for their records, call it good and move forward. 

And I agree, simplifying the formula to be 25% of deferrals period would be easier. If my math is correct it would only affect participants who make less than $104,166 (6,250 /.06)AND who deferred more than 24%, so if it is just the 3 people you've found, that's a pretty small group. 

[Cardscrazy]

Thank you Justanotheradmin!  I appreciate you putting scope around the type of participants who are impacted by the capping of the match to no more than 6% of wages.  I will find the ACP test, but I presume they passed.  And so you think that this was an overall permissible interpretation of 25% of contributions, up to 6% of wages?   Well, at least I'd force them to document their interpretation of the formula and maybe stop the capping going forward.  Clean up how they express the match to employees.  I guess at least I didn't cause a stir for no good reason or end result I should say.  Thank you!