QUESTION: Our 401(k) plan satisfies the nondiscrimination safe harbor under Code § 401(k)(13) by requiring an automatic deferral of 3.5% for each new employee who does not affirmatively elect a different percentage (or zero), and by providing a 100% matching contribution of up to 3.5% of compensation. We have procedures in place to automatically enroll new employees, but due to an administrative error, one new employee was not enrolled for an entire calendar year. How do we self- correct this failure?
ANSWER: The IRS’s Employee Plans Compliance Resolution System (EPCRS) offers several pre-approved methods that can be used to correct failures to implement automatic deferrals. The standard method for correcting full-year elective deferral failures (including enrollment failures under an automatic contribution arrangement) involves making a qualified nonelective contribution (QNEC) for 50% of the missed deferrals plus a contribution for the full amount of any missed matching or nonelective contributions (see our Checkpoint Question of the Week). But lower-cost methods may be available if the correction is made within specified timeframes. One of these methods reduces the QNEC for the missed deferrals to 25% of the missed deferrals if the correction occurs within the three-year period for self-correcting significant failures, or, if earlier, by the end of the month after the month the employee notifies the plan sponsor of the failure. Another method requires no QNEC for the missed deferrals if correct deferrals commence no later than the first paycheck issued after the three-month period that began when the failure first occurred (earlier if the employee notified the plan sponsor of the failure).
Even though your new employee was excluded for more than three months, you may still be able to avoid a QNEC for that employee’s missed deferral opportunity using a temporary correction method that is available only for automatic contribution arrangements. This method originally expired at the end of 2020, but it was retroactively reinstated in the 2021 version of EPCRS for errors beginning before 2024 (see our Checkpoint article). Here is a summary of the requirements for using this temporary, lower-cost method:
Avoiding a QNEC. To avoid making a QNEC for the missed deferrals, you must (1) correct the failure by the first compensation payment made on or after the last day of the 9-1/2 month period following the end of the plan year of the failure or, if earlier, by the end of the month following the month in which the employee gives notice of the failure; (2) provide a notice to the employee not later than 45 days after correct deferrals begin (see below); and (3) make corrective contributions (adjusted for earnings) for any missed matching contributions.
Content of 45-Day Notice. The notice must include (1) general information relating to the failure, including the percentage that should have been deferred and the approximate date that the deferrals should have begun; (2) a statement that correct deferrals have begun (or will begin shortly); (3) a statement that corrective contributions for missed matching contributions have been or will be made; (4) an explanation that the employee may increase the employee’s deferral percentage to make up for the missed deferral opportunity (subject to the Code § 402(g) annual dollar limit); and (5) the plan’s name and contact information (including street address, email address, and telephone number).
QNEC for Missed Matching Contributions. The correction method requires a QNEC for any missed matching contributions. (For your plan, the QNEC would be 3.5% of the employee’s compensation as defined for determining automatic deferrals.) The QNEC must be 100% vested, and it must not be distributable before death, disability, severance from employment, age 59-1/2, or plan termination, except as a hardship distribution. The QNEC must be adjusted for earnings to the date of the correction, which under a special rule may be based on the earnings of the plan’s default investment alternative if the employee did not affirmatively designate an investment.
For more information, see EBIA’s 401(k) Plans manual at Sections XXII.D (“QACA: ADP Safe Harbor Automatic Contributions”), XXXIV.E.3 (“Failure to Implement an Automatic Contribution Feature”), and XXXV.D (“Self-Correction Program (SCP)”).
Contributing Editors: EBIA Staff.