IRS Provides Relief for Correction of Elective Deferral Mistakes in 401(k) Plans

The IRS recently announced changes that make it significantly easier to correct employee deferral mistakes (also known as elective deferrals) in qualified retirement plans.  The changes make modifications to the IRS’ Employee Plans Compliance Resolution System (“EPCRS”), which is the IRS’ comprehensive correction program for qualified retirement plans.

Automatic Enrollment Correction Relief

If a qualified plan has automatic enrollment and it either (1) does not automatically enroll employees in accordance with the terms of the plan’s automatic enrollment feature or (2) does not implement an employee’s affirmative election, the new guidance provides that as long as the employee is enrolled in the plan within 9-1/2 months following the end of the plan year of the failure (or earlier if the employee notifies the employer of the mistake), the employer is not required to make a correction for the missed elective deferrals.  The employer still must make a correction equal to the matching contributions on the missed elective deferrals.

The guidance is intended to encourage employers to adopt automatic enrollment and automatic escalation features in their retirement plans.  This correction relief makes automatic enrollment features more attractive since it gives employers the opportunity to find and correct mistakes without additional employer costs.

Expansion of Correction for Elective Deferral Errors in Plans without Automatic Enrollment

The IRS also has made it easier and less expensive to correct elective deferral errors in plans that do not have automatic enrollment features.  If the elective deferral failure occurs for less than three months, the employer does not have to make a contribution for the missed elective deferrals.  The employer is, however, required to make a correction equal to the matching contributions on the missed elective deferrals.

If the elective deferral failure continues for more than three months, the employer must make a corrective contribution equal to 25% of the missed elective deferrals as long as the correction is made within the time period described in the revenue procedure (generally within two years following the year of the plan failure).  The employer also must make a corrective contribution equal to the matching contributions on the missed elective deferrals.  Before this guidance, employers were required to make a corrective contribution equal to 50% of the missed elective deferrals, so this guidance reduces the costs of correcting these types of common errors.

To take advantage of this relief, employers may wish to have a process in place to find and correct deferral errors promptly.