EBIA Weekly Newsletter

How Do We Self-Correct a Failure to Enroll a New Employee in Our 401(k) Automatic Contributions?

   March 24, 2016

QUESTION: Our 401(k) plan uses the ADP safe harbor design under Code § 401(k)(13). The plan requires an automatic deferral of 3.5% for each new employee who does not make an affirmative election to contribute at a different percentage (or not at all), and employees receive a 100% matching contribution up to 3.5% of compensation to satisfy the ADP safe harbor. We have procedures in place to automatically enroll each new employee, 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 pre-approved methods for correcting failures to implement an automatic contribution feature. Informally, the IRS had indicated that the pre-approved method to correct a failure to include an eligible employee applies to a failure to implement automatic contributions (see our Checkpoint Question of the Week). Since then, however, the IRS amended EPCRS to provide several lower-cost correction methods, including one specifically for automatic contribution failures that begin before 2021 (see our Checkpoint article). Under that method, your company may be able to avoid making a qualified nonelective contribution (QNEC) for the missed deferrals if certain requirements are met. (The IRS’s earlier informal position required a QNEC based on 50% of the missed deferrals.) Here is a summary of the requirements for using this 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; 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 participant may increase the participant’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, or as a hardship distribution. Also, plan forfeitures cannot be used to fund the QNEC. 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.

If you cannot use this method—for example, because the correction occurs after the 9-1/2 month period—one of the other methods may still be available, but the correction will likely cost more.

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) for Operational Failures”). You may also be interested in our upcoming webinar “Common Mistakes and How to Fix Them: 401(k) Plans.”

Contributing Editors: EBIA Staff.