Relief for Elective Deferral Failures – Sept./Oct. 2015

An elective deferral failure occurs when a plan sponsor fails to correctly implement an elective deferral. This includes deferrals participants “elect” to make (affirmative elections) and deferrals based on a plan’s automatic contribution features (including automatic escalation).

An elective deferral failure also occurs if a plan sponsor fails to provide an employee with the opportunity to make an affirmative election because the employee was improperly excluded from the plan.

An EPCRS update

The IRS received comments that said the existing elective deferral correction rules overcompensate participants when deferral failures last for short periods. The IRS also received feedback indicating that high costs related to correcting elective deferral failures in automatic contribution arrangements were discouraging employers from adopting automatic contribution features (e.g., automatic enrollment and automatic escalation). In response, the IRS released Revenue Procedure 2015-28, which presents three new methods for correcting elective deferral failures in 401(k) and 403(b) plans. This is an update to its Employee Plans Compliance Resolution System (EPCRS).

Comparing the rules

Prior to the changes introduced by Rev. Proc. 2015-28, the missed deferral opportunity cost was generally based on 50 percent of the missed deferral. But it was also based on the type of failure:

• When a participant was improperly excluded, the missed deferral cost was 50 percent of the missed deferral, based on the actual deferral percentage average for the participant’s group (highly compensated or nonhighly compensated employees).
• For safe harbor 401(k) plans, the missed deferral cost was 50 percent of a 3 percent deferral. For a safe harbor plan with an enhanced match, the missed deferral was 50 percent of the percentage that receives a dollar-for-dollar match.
• When a participant filed a salary deferral election that was not implemented, the correction was 50 percent of the amount the participant elected.
• When an eligible participant failed to be automatically enrolled, the missed deferral cost was 50 percent of the deferral that should have occurred.

Note: There was an exception to the missed opportunity cost outlined above if there were at least nine months of the plan year remaining after deferrals started.

If the plan called for matching contributions, the employer contributed an amount equal to the total matching contribution the participant would have received had his or her deferrals been handled correctly.

There are three new rules under Rev. Proc. 2015-28:

I) There will be no missed deferral opportunity cost for automatic enrollment or automatic increase (escalation) failures that are found and corrected by the first payroll date after the earlier of:

• Nine and a half months after the end of the plan year in which the automatic contribution or increase should have occurred, or
• The last day of the month following the month in which the participant advises the sponsor of the problem.

Example 1: An individual became eligible to participate in his or her employer's plan on July 1, 2015, and the plan administrator failed to automatically enroll the individual. This error is discovered on February 1, 2016, by the plan administrator. The individual is automatically enrolled in the plan on the next payroll date and is provided with a notice of the failure within 45 days of the elective deferral beginning. No corrective contribution is required because the error was discovered within nine and a half months after the end of the plan year in which it occurred, and the corrective action was made in a timely manner.

II) The missed deferral opportunity cost for errors in implementing affirmative elections, automatic enrollment, and automatic increases discovered within three months:

There will be no employer corrective contribution required for missed deferrals that happened within the prior three months (this is a "rolling three-month period") if deferrals are restarted by the first payroll date after the earlier of:

• Three months after the missed deferrals occurred, or
• The last day of the month following the month in which the individual advises the sponsor of the problem.

Example 2: An individual became eligible to participate in his or her employer’s plan on July 1, 2015, and the plan administrator failed to automatically enroll the individual. This error is discovered by the individual on August 10, 2015. After informing the plan administrator of the error on August 10, the individual is automatically enrolled in the plan on August 28, 2015. No corrective contribution is required because the error was less than three months in duration, and the elective deferrals began before the end of the month after the month the plan sponsor was notified of the problem. Also, the individual was provided with a notice of the failure within 45 days of elective deferrals beginning.

III) The missed deferral opportunity cost for errors in implementing affirmative elections, automatic enrollment, and automatic increases found within the EPCRS Self-Correction Program (SCP) correction period for significant errors (i.e., the last day of the second year following the plan year in which the error occurred):

The employer corrective contribution required for missed deferrals is reduced from 50 percent to 25 percent for missed deferrals that fall outside of the time periods given in the prior examples but are corrected by the last day of the second year following the plan year in which the error occurred.

Example 3: An individual became eligible to participate in his or her employer’s plan on June 1, 2015, and completed and submitted a salary deferral election form for 6 percent of compensation on the same day. The plan administrator failed to enroll the individual. There is a 50 percent match on deferrals up to 6 percent. The error is discovered by the participant on January 28, 2016, and the individual is enrolled in the plan on the next payroll date. The plan administrator is required to make a corrective contribution under EPCRS because the error was not discovered within three months. However, the missed opportunity corrective contribution will be 25 percent of 6 percent of compensation, or 1.5 percent of compensation, plus earnings (rather than 50 percent of 6 percent) because the failure error lasted longer than three months and the correction is being made within the SCP correction period for significant errors. There is also an employer corrective contribution required for the associated match: 50 percent of 6 percent from June 1, 2015, until the date the corrective contribution is made plus earnings. Depending on plan design, the corrective matching contribution may be made as a qualified nonelective employer contribution (QNEC), a qualified matching contribution (QMAC), or an employer matching contribution. If the employer matching contribution is selected, it may be subject to the employer’s vesting schedule.

Note: The difference between Example 3 and Example 1 is that Example 3 did not involve an automatic enrollment situation. Rather, the deferral election the participant filed was not implemented, so the nine and a half month period was not applicable.

Under all these new correction methods, the employer must also:

1. Make a matching contribution in the amount the participant would have received had the deferrals been handled correctly in the first place,
2. Provide a notice to the affected participants within 45 days of the date on which the proper deferrals started occurring, and
3. Calculate (and contribute) lost earnings for any corrective contributions the employer is required to make.
   • For automatic enrollment failures where no investment election has been filed, earnings may be calculated using the earnings rate of the plan’s default investment. (This is a new earnings calculation method.)
   • For other missed deferral failures, the earnings are based on one of the four existing earnings calculation methods found in EPCRS Appendix B, Section 3.

Note: If the investment suffered a net loss, the loss may not reduce the required corrective contribution.

Failure to implement elective deferrals in automatic contribution feature

The guidance states that the automatic contribution corrections above will apply to these types of failures that occur between now and December 31, 2020. The IRS will then consider whether to extend them by taking various factors into consideration, including whether there is an increase in the number of plans that implement automatic contribution features.

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