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Benefit Plans: New Relief for Missed Employee Elective Deferrals
The IRS recently modified the Employee Plans Compliance Resolution System (EPCRS) to provide for new “safe harbor” methods of correcting employee elective deferral failures in 401(k) and 403(b) plans. The IRS Revenue Procedure 2015-28 applies to plans with and without an automatic contribution feature.
The method can be applied when an employer fails to correctly implement elective deferrals in situations involving:
- An employee’s affirmative election to defer, or
- An automatic contribution feature (including an automatic escalation feature), or
- A missed opportunity to make an affirmative election because an employee was improperly excluded from the plan.
Reluctance to use automatic enrollment plans
The IRS solicited comments regarding this change, and commenters pointed out that the EPCRS rules prevented employers from adopting automatic enrollment plans, because of the high cost of making corrections. Commenters also pointed out that such deferral failures occur with a greater frequency in plans with automatic contribution and escalation features.
Under previous rules, employers were required to provide for a 50 percent corrective contribution (a 100 percent-vested Qualified Non-Elective Contribution (QNEC) employer contribution) to employees for their failure to implement salary deferrals in 401(k) or 403(b) plans.
Commenters argued this created a “windfall” for affected employees, who received their full salaries plus the 50 percent corrective contribution. They stated that this overcompensated affected participants for failures that are of a short duration because, in many instances, those employees have the opportunity to increase their elective deferrals to “make up” for the shortfall at a later date.
To the IRS, the underlying principle was that the corrective contribution should make up for the value of the lost opportunity of an employee’s tax-deferred savings and earnings, and the IRS assumed the participant would not have the opportunity to increase elective deferrals in later periods to make up for the missed contributions and earnings. The new IRS safe harbor rule balances its concern for participants’ lost savings, as well as the cost to employers.
The IRS provides a thorough discussion of its new methods for correcting elective deferral errors including details on automatic contributions, early corrections, matching contributions, and missed earnings. In certain instances, no QNEC is required for missed elective deferrals, while a 25 percent QNEC is required if certain other conditions are met (the required QNEC was 50 percent prior to this revenue procedure). Section 4 of Revenue Procedure 2015-28 also clearly specifies the content that needs to be included in the written notice to an employee who has been affected by an elective deferral failure.
One important point to note is that in cases where the participant notifies the employer of an elective deferral failure, the correction must be made by the following month. This is significantly quicker than when the error is discovered by the employer or auditor.
These new safe harbor correction rules sunset on December 31, 2020. The IRS may extend this correction method after evaluating several factors, one being the increase in the number of plans with automatic contribution features. Although the details may sound complex, the IRS has actually made it considerably easier to correct a common and costly mistake.