Ineligible employee allowed to defer to 401k

[ConnieStorer]

I have an ineligible employee who was allowed to defer prior to meeting eligibility.  I would normally just amend the Plan to allow early entry for this employee.  My only concern is that the Plan is Top Heavy.  Is there anyway to avoid allocating a Top Heavy Benefit to this employee?

[Peter Gulia]

Might the employer have paid the amounts under a mistake of fact so that the plan's administrator and trustee might return to the employer the amounts mistakenly paid?

This is not advice to anyone.

[ConnieStorer]

I would like to think this would work but the deferrals were reported on the 2023 W-2.  They were Roth so no tax consequences to the participant.

[Paul I]

Is it fair to assume that the employee was not eligible throughout all of 2023?  If yes, then correct the ineligible deferrals by distributing the excess amounts to the employee.  You are correct that there would be not tax impact to the employee with the exception that any related earnings would be taxable in 2024.  If the employee is now eligible and not deferring the maximum, they can up their deferrals to put the amount back into the plan.  The Plan Sponsor is not on the hook for a 2023 top heavy contribution but the Plan Sponsor likely will pay the price of dealing with a disgruntled employee.

[Ilene Ferenczy]

EPCRS allows you to consider all amounts contributed by the participants to be excess allocations.  To quote myself and my co-authors of the Plan Correction eSource on ERISApedia:

 

Let’s suppose that the early entrants were predominantly HCEs or the plan sponsor doesn’t really want to include the affected employees—there is an alternative. The plan may treat the funds contributed to the plan by the early included employees as Excess Allocations. This means that the plan sponsor can correct the failure by distributing to the affected employees the elective deferrals they made to the plan, including earnings. Any employer money funded on behalf of such employees, and earnings thereon, should be forfeited, to be used in accordance with the terms of the plan.

Having said this the 3% top heavy minimum for a new entrant cannot be that expensive.  Is it worth the potentially bad employee reaction to return the funds to avoid the TH minimum?  Just sayin'.