How do we correct discrimination about the availability of a kind of distribution?

Imagine a group of commonly controlled business organizations.  All have a § 401(k) plan.  None is a safe-harbor plan.  The group has no troubles with coverage, ADP, or ACP tests.

Some plans allow hardship distributions; some don’t.  Imagine that resulted in § 401(a)(4) discrimination in favor of highly-compensated employees.

For a year that ended, what may the employers do to cleanse the discrimination defect?

If it can’t be done by self-correction, what would the IRS ask for?

SCP is available to correct operational failures and certain plan document failures.

An operational failure is a failure that arises when the plan does not follow the terms of its plan document. If the plan is making hardship distributions available in accordance with its document, then there is not an operational failure to self-correct. Violation of the nondiscrimination rules of 401(a)(4) results in a demographic failure, which can not be corrected by SCP.

That is as far as I am willing to go with any degree of certainty. Wild speculation follows....

Considering that VCP is a voluntary submission, and the plan sponsor's submission to the IRS must include a proposed method of correction, I think the question is less "What would the IRS ask for" in terms of a correction, but more "What proposal might the IRS find acceptable?"

If there were any demonstrable harm resulting from the failure, that would be a good starting point. For example, if an NHCE terminated employment in a prior year in order to gain access to their retirement funds, but might have remained employed if a hardship withdrawal option had been available to them at the time, then maybe the plan could propose making additional contributions to this employee to make up for the plan years that the employee missed out on.

It's harder if there are no specific events to look to. The plan sponsor might say that there were no requests for distributions, therefore it is reasonable to conclude that no one would have taken one even if they had been available, therefore there was no actual harm done by the non-availability of hardship distributions, therefore no correction is needed. However this discounts the possibility that the NHCEs might have made 401(k) contributions at a greater rate if they knew they would have access to their contributions in the event of a pre-retirement financial hardship. Therefore the sponsor might be justified in proposing to make additional contributions to each NHCE's account for the period which the failure occurred, to make up for the lost deferral incentive (a term I just made up). 

Maybe, and this is a real stretch, the plan would consider "invalidating" the hardship withdrawal provision for any years that 401(a)(4) was not satisfied. This might involve requiring any HCEs who received hardship withdrawals during that time to repay those withdrawals to the plan, with earnings. I think this is unlikely to be acceptable since plan correction principles are generally not in favor of cutting back participants' rights under the plan, even HCEs' rights.

This an interesting question. Thanks for asking!

Thank you for your excellent analysis and helping me think about this.

You may also want to look at 1.401(a)(4)-11(g). You may outside of the 9 1/2 month correction period, but it has rules for correction by amendment for failure to satisfy benefits, rights or features. You can’t retroactively change what happened so the correction is a prospective amendment.  

Peter, you state that the plans have no problem with coverage. If that means that each plan in the group satisfies coverage requirements on its own, wouldn't that mean that the plans would each satisfy nondiscrimination requirements with respect to the availability of hardship distributions?

Ken, I meant only that § 410(b) coverage was met about which people are eligible for allocations of elective, nonelective, and matching contributions and what contributions are allocated.

(And even that information suffers from telephone effect.  The accounting firm that did the testing reported to the parent’s outside counsel, not me, who advised the parent’s inside counsel, who said something to the parent’s HR, who told a subsidiary’s HR, who told one of the subsidiary’s inside assistant counsels, who called me.)

G8Rs, thank you for your thought about 26 C.F.R. § 1.401(a)(4)-11(g).