Employer Fails to Change Employee 401(k) Contribution Rate. Is Correc

[LCARUSI]

401(k)Plan Sponsor receives a request from an employee to increase 401(k) contribution rate from x% to y% in 1999. Employer reports change to recordkeeper but fails to process the request on payroll. Therefore, the employee continues to contribute to the Plan at the rate of x% instead of y%.

Employee never notices the error and the error is now identified by the sponsor. The participant's quarterly statements have all reflected the participant's actual contributions at the rate of x%. However, each quarterly participant statement incorrectly contained the following statement:

"Your currrent contribution rate is y%"

As a result of this error, the participant received compensation that should have been deferred into the Plan.

The employee is an NHCE. No matching contribution was lost due to this error because the Plan does not match contributions in excess of x%.

Is the Sponsor required to take any corrective action?

[MWeddell]

I could imagine two arguments for why the IRS would think this needs to be corrected.

The employer has operated the plan in a manner that fails to comply with the plan document, because the document very likely gives the participant the right to change his or her contribution percentage election. The various EPCRS Revenue Procedures make clear that the IRS regards that as a qualification problem. I think that's very debateable, but prior threads on these Benefit Boards indicate my view may be a minority position. Hence, the IRS probably views this as requiring correction.

A second argument is possible. Failure to implement the employee's modification to his or her contribution election may cause the plan to no longer have a "cash or deferred election" under Reg. 1.401(k)-1(a)(3) and hence no longer have a "cash or deferred arrangement" under Reg. 1.401(k)-1(a)(2). I don't think it's a strong argument because suppose the employer intentionally was trying to do this (presumably because it preferred 401(a)(4) testing to ADP/402(g) testing). I think the IRS would say failure to implement the modification doesn't prevent it from being a cash or deferred arrangement unless the conditions of Reg. 1.401(k)-1(a)(3)(iv) are met. After considering this second argument, I'd reject it.

Note that pragmatically, I can see why the employer may choose to ignore the situation: it may feel that the employee hasn't really been hurt and that chances of IRS or DOL detection are nil.

[Earl]

I think the answer is that correction is required. There def. was an error and the Participant has been impacted in a measurable way.

Now, as with many things in the private pension world, required doesn't mean it is going to really happen.