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“I’m confused about the deadlines for correcting 401(k) plan excesses. Can you give me quick tutorial?”

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ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Minnesota is representative of a common inquiry regarding 401(k) plan nondiscrimination testing.

Highlights of Discussion

I’ll try my best to summarize, generally, but be sure to seek out tax and/or legal advice for actual plan situations. One of the characteristics that sets 401(k) plans apart from other defined contribution plans are the unique contribution limits that apply to employee salary deferrals and matching contributions, namely the actual deferral percentage (ADP) limit, the actual contribution percentage (ACP) limit, and the IRC Sec. 402(g) annual deferral limit.

I’ll cover the three following excesses in this space:

  1. ADP failures—where the highly compensated employees (HCEs) defer too much in relation to the nonHCEs and create “excess contributions” [IRC Sec. 401(k)(8)(b)]
  2. ACP failures—where matching and/or after-tax contributions are too high for HCEs in relation to those for nonHCEs and create “excess aggregate contributions” [IRC Sec. 401(m)(6)(B)]
  3. 402(g) failures—where plan participants, either HCEs or nonHCEs, defer above the annual limit and create “excess deferrals” [IRC Sec. 402(g)(3)]
401(k) Excess Correction Deadlines
Type of 401(k) Excess Time of Correction Consequences of Failing to Timely Correct
Excess Contributions (ADP test failure where HCEs defer too much compared to nonHCEs)

 

Or

 

Excess Aggregate Contributions (ACP test failure where HCEs’ matching and or after-tax contributions are too high compared to nonHCEs’)

 

 Within 2½ months after plan year end (March 15th for a calendar year plan)

Issue corrective distributions to affected HCEs

 

 

 

 Excess and earnings taxed in the year distributed

 

 
After 2 ½ months after plan year end

 

Two Corrective Options:

1. Issue corrective distributions to HCEs

or

2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure

 ·     Excess and earnings taxed in the year distributed

·     Employer subject to a 10% penalty tax
After the end of the plan year following the year of the excess

 

 ·   Employer subject to a 10% penalty tax

·   Potential for plan disqualification

·   Correct through Employee Plans Compliance Resolution System (EPCRS)

 
If “eligible automatic contribution arrangement” Excess Contribution or Excess Aggregate Contribution

 

 6 months following the end of the plan year (June 30 for calendar year plan)

 

Issue corrective distributions to affected HCEs

 

 Excess and earnings taxed in the year distributed
After 6 months following the end of the plan year

 

Two Corrective Options:

 

1. Issue corrective distributions to HCEs or

2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure

 ·   Excess and earnings taxed in the year distributed

 

·   Employer subject to additional 10% penalty tax

 
After the end of the plan year following the year of excess (December 31 for calendar year plan)

 

 ·      Employer subject to additional 10% penalty tax

·      Potential for plan disqualification

·      Correct through EPCRS

 
Excess Deferrals (402(g) failure, Pre-Tax and Designated Roth) On or before April 15th of year after deferral

Issue corrective distributions of excess deferrals, plus their earnings

 ·      Excess deferral taxed as income in the year deferred.

·      Earnings on excess taxed in the year distributed.
After April 15 of year following excess

 

 ·   Excess deferral taxed in the year deferred.

·   Both the excess deferral and earnings taxed in the year removed.

·   If excess deferrals result from deferrals to one or more plans maintained by the same employer, possible loss of qualified plan status

 

Amounts in excess of any one of these limits could have serious consequences for the employer, the participant and/or the plan as a whole. Plan penalties are costly to plan sponsors and every effort should be made to avoid them. But worse than paying the IRS an extra penalty fee is the potential loss of qualified status for the 401(k) plan. If the IRS disqualifies a plan, the plan sponsor loses the tax-saving benefits of the plan, and the assets become immediately taxable to the participants. Therefore, such excesses must be avoided and timely corrected when failures occur.

Conclusion

Treasury regulations contain clear steps and deadlines by which plan sponsors must correct 401(k) excesses. If done so timely, the plan sponsor can avoid additional penalties and potential plan disqualification. Corrections made after the specified deadlines must follow the terms of the IRS’s EPCRS.

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Still Time for a 2020 Nonelective Safe Harbor Plan?

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“Although it is already November, can my client amend her traditional 401(k) plan to be a safe harbor plan for 2020?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Illinois is representative of a common inquiry related to safe harbor plans.

Highlights of the Discussion

Yes, but she must hurry. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 relaxed the deadline for amending a 401(k) plan to add a safe harbor nonelective contribution for the current year.

Under Section 103 of the SECURE Act, plan sponsors may amend their plans to add a three percent safe harbor nonelective contribution at any time before the 30th day before the close of the plan year. The SECURE Act also did away with the mandatory participant notice requirement for this type of amendment.

Furthermore, amendments after that time would be allowed if the amendment provides

1) a nonelective contribution of at least four percent of compensation for all eligible employees for that plan year,

and

2) the plan is amended no later than the close of the following plan year.

EXAMPLE:

Safety First, Inc., maintains a calendar-year 401(k) plan. Based on the plan’s preliminary actual deferral percentage (ADP) test (which the plan is failing), Safety First decides a safe harbor plan is a good idea for 2020. It’s too late to add a safe harbor matching contribution for 2020. However, the business could add a three percent safe harbor nonelective contribution for the 2020 plan year (without prior participant notice) as long as Safety First amends its plan document prior to December 1, 2020. While Safety First still could add a nonelective safe harbor contribution to the plan for 2020 after that date, the minimum contribution would have to be at least four percent of compensation, and the company would have to amend its plan document no later than December 31, 2021.

Conclusion

Thanks to the SECURE Act, 401(k) plan sponsors have more flexibility to amend their plans for “safe harbor” status. Plan sponsors who are failing their ADP tests for the year may find this type of plan amendment attractive as a correction measure.

 

 

© Copyright 2024 Retirement Learning Center, all rights reserved