401(k)ology – Missed Deferral Opportunity Corrections – New Rules!
Published August 15, 2024
When a plan sponsor inadvertently fails to implement automatic enrollment for an eligible employee or fails to provide an eligible employee the opportunity to make elective deferrals, there is a missed deferral opportunity that must be corrected in accordance with the published regulations and guidance.
Pursuant to the Employee Plans Compliance Resolution System (Revenue Procedure 2021-30), and before the issuance of Notice 2024-2, the only missed deferral correction available for employees who had terminated employment was the use of the 50% qualified non-elective contribution (QNEC).
In this blog we will provide an overview of the corrective actions required when employees experience a missed deferral opportunity (MDO) and highlight the new rules that plan sponsors may take advantage of post December 31, 2023.
The first post in the 401(k)ology series was published a little over two years ago on the topic of—wait for it—Missed Deferral Opportunities (MDO)! So much has changed since April 2022 that it warrants an update to the MDO correction process. New rules, and they are (thankfully) good rules! So, what is new?
Section 305 of SECURE 2.0 requires the Treasury Department to update the Employee Plans Compliance Resolution System (EPCRS, most recently updated in Revenue Procedure 2021-30) to incorporate the expanded use of the Self Correction Program (SCP) by December 29, 2024. EPCRS provides the framework of plan correction principles and correction methods relating to operational failures impacting retirement plans, including MDOs.
SECURE 2.0 significantly expands the ability for plan sponsors to correct common deferral errors that occur in the operation of 401(k) and 403(b) plans, specifically those that include an Automatic Contribution Arrangement (aka Automatic Enrollment). While we await the release of the updated EPCRS, the IRS released Notice 2024-2 that includes specific questions and answers addressing the newly available ability to apply the reduced MDO correction option (of 0% or 25%, instead of the standard 50%) in situations where the affected employees who have already terminated employment!
Plus, the original safe harbor MDO correction methods available under EPCRS were originally only temporary and subject to periodic extensions to remain available. The most recent extension was slated to expire on December 31, 2023, but SECURE 2.0 has now made these reduced contribution MDO correction methods permanent.
These are big wins for plan sponsors in correcting plan errors, so let’s review some of the basics and dive into the new rules!
Missed Deferral Opportunity Basics
Common missed deferral opportunities include:
The failure to implement an employee’s affirmative election
The failure to enroll an eligible employee
The failure to implement the plan’s automatic enrollment or automatic increase with respect to one or more eligible employees
The failure to apply a deferral election to the correct compensation
Practice Note: The failure to apply deferral elections to the correct compensation results in a missed deferral opportunity equal to the difference between what was actually withheld and what should have been withheld had the correct definition of plan compensation been applied. The 45-day notice requirement must be satisfied, and the clock starts on the date the correct deferrals are withheld. If the notice window is not met, the reduced QNEC may not be used. As an example, this occurs quite frequently when employers mistakenly fail to include the employee’s elected deferral amount with respect to bonus payrolls. Not all missed deferrals may be corrected in the same manner—there are variables based on the specific facts, circumstances and timing.
Standard EPCRS Correction Methods for Missed Deferral Opportunities
The following are the standard MDO correction methods where eligible employees are incorrectly excluded from the plan:
Pre-Tax Elective Deferrals – If an employee was not given the chance to make deferrals, the employer must make a QNEC equal to 50% of the “missed deferral,” which is calculated based on the average deferral percentage of the employee’s group (highly compensated or non-highly compensated) and their eligible plan compensation. The QNEC is adjusted for earnings from the date of the failure through the date of the corrective deposit. The missed deferral amount is also capped at the annual deferral limit under IRC §402(g) in effect for the calendar year.
Roth Deferrals – If the employee was excluded from making Roth contributions, the correction is the same as for pre-tax deferrals. Note that the QNEC is pre-tax rather than Roth.
Catch-Up Contributions – If an employee who was over age 50 in the calendar year missed the opportunity to make age 50+ catch-up contributions, the employer must make a QNEC equal to 50% of the missed catch-up contributions for the year, adjusted for earnings. This is based on one-half of the maximum catch-up contribution limit in effect for the calendar year.
After-Tax Contributions – If an employee missed the opportunity to make after-tax contributions, the employer must make a QNEC equal to 40% of the employee’s missed after-tax contributions, which is calculated based on the average contribution percentage (ACP) of the employee’s group (highly compensated or non-highly compensated) and their eligible plan compensation. If the ACP includes both matching and after-tax contributions, the employer may base the QNEC on the portion of the ACP that is attributable to after-tax contributions. The QNEC is adjusted for earnings from the date of the failure through the date of the corrective deposit.
Employer Matching Contributions – If the employee missed any matching contributions, the employer must contribute what the employee would have received as a match, adjusted for earnings from the date of the failure through the date of the corrective deposit.
Safe Harbor 401(k) Plans – If the plan uses a safe harbor approach to satisfy the annual nondiscrimination testing requirements (ADP/ACP Tests), the missed deferral is either 3% of the employee’s eligible compensation (nonelective safe harbor formula) or the maximum percentage at which the safe harbor formula matches at 100% (for the basic or enhanced match formulas). The employer makes a QNEC equal to 50% of the missed deferral plus any safe harbor nonelective or safe harbor matching contributions, adjusted for earnings from the date of the failure through the date of the corrective deposit.
403(b) Plans – The correction is similar to that of a 401(k) plan; however, the missed deferral is the greater of 3% of eligible compensation or the maximum percentage at which the employer matches deferrals at 100% of eligible plan compensation.
Missed Employee Deferral Elections
If the employer either failed to implement an employee’s affirmative election or used the incorrect percentage or dollar amount in determining the deferrals, the correction is the same as those listed above; provided, however, that the missed deferral opportunity (pre-tax or Roth) or missed contribution (after-tax) is based on the employee’s actual election and compensation, adjusted for earnings. If any election would have been matched, the employer must include the missed matching contribution, adjusted for earnings.
EPCRS Reduced Contribution Safe Harbor Correction Methods
The reduction contribution safe harbor correction methods come in two varieties: short term failures, and failures that occur in plans that utilize automatic contribution provisions.
Short Term Failures (3 Months) – If the MDO does not exceed three (3) months, no QNEC is required if corrections are made within specific timelines, and the plan sponsor provides a required notice to the affected participants within 45 days of the date the correct deferrals begin. For after-tax contributions, the requirement is that the employee must be able to make after-tax contributions for at least the last 9 months of the Plan Year, otherwise the 40% QNEC applies.
Failures Lasting More than 3 Months – If the MDO lasts more than three (3) months, the QNEC is reduced to 25% (instead of 50%) if corrections are made within specific timelines and the plan sponsor provides a required notice to the affected participants within 45 days of the date the correct deferrals begin.
Extended Correction Period for Automatic Contribution Arrangements – If the failure is related to missed automatic contributions or missed affirmative elections, and the failure is corrected within 9.5 months after the end of the plan year in which the MDO occurred, no QNEC is required as long as the plan sponsor timely provides the required 45-day notice. If the failure is not corrected within this period, the QNEC is 25% of the MDO and the notice must be provided within 45 days of the correct deferrals starting.
Note: If the employee alerts the employer of the error, the correct withholding must begin by the first paycheck after the month following the month the error was discovered.
Required Content in the MDO Notice
A notice must be provided to each affected participant when taking advantage of the reduced 0% or 25% QNEC options for a short-term MDO, as described above. The notice must include:
The percentage or dollar amount of plan compensation that should have been deferred
The date the deferral election should have been implemented
The date the correct withholding began
If applicable, a statement that the plan sponsor will be/has made corrective contributions
A statement that the employee can adjust their future withholding
A statement that any applicable matching contributions have been/will be made
The plan name and plan sponsor’s contact information
New Rules under Section 350 of SECURE 2.0 (IRS Notice 2024-2)
Section 350 of SECURE 2.0 aims to make it even easier for employers to correct deferral mistakes without penalties, as long as certain guidelines are followed. These new correction guidelines outlined below are specific to plans that include automatic enrollment and/or auto-escalation provisions and are effective for correction dates after December 31, 2023.
Deadline for Deferral Corrections – The earlier of the 1st payroll date following the 9.5-month period (for calendar year plans that would be the first pay date following October 15th) or the first payroll date on or after the last day of the month following the month in which the employee notified the employer of the error.
Deadline for Matching Contributions – The corrective allocation of matching contributions is generally required within 6 months of when correct deferrals start, or by the end of the third plan year following the year the MDO first occurred.
Nondiscriminatory Application – The errors must be corrected for all similarly situated participants in a nondiscriminatory manner and employees affected by the error must receive the notice within 45 days after the date on which correct deferrals begin.
Applicability to Terminated Participants – The new guidance included in Notice 2024-2 provides the ability to use the reduced 0% and 25% QNEC for both active and terminated employees. Prior to Notice 2024-2, employers could not take advantage of the reduced contribution safe harbor methods for terminated participants, who were required to receive the full 50% QNEC. This exclusion for terminated employees was presumably because the required 45-day notice could not be satisfied where the employee was no longer employed, thus no deferral start date.
Notices for Terminated Participants - Notice 2024-2 clarifies that the 45-day MDO notice for terminated participants is not required to include a statement that deductions have or will begin shortly, and it is not required to include an explanation that the terminated participant may increase future deferral elections to make up for the MDO. Needless to say, both of those items are inapplicable post-termination of employment.
Examples – Using the 9.5-Month rule
Example 1 - Facts:
Company Z maintains a 401(k) plan based on the calendar year
The 401(k) plan includes automatic enrollment provisions, there is no employer match
Company Z failed to automatically enroll a participant on January 1, 2023, and the participant subsequently terminates employment on November 14, 2023
The participant has not notified Company Z that deferrals were not deducted
Company Z’s payroll is semi-monthly on the 15th and last day of the month
The plan year in which the failure occurred was the plan year ending December 31, 2023. October 15, 2024 is the date that is 9.5 months after the end of the plan year. The next paycheck after that date (had the participant remained employed) would have been October 31, 2024. Therefore, October 31, 2024, is the deadline for Company Z to apply the correct withholding. Since October 31, 2024 is after the effective date of new Section 414(cc) added by Section 350 of SECURE 2.0, Company Z can use the automatic enrollment safe harbor to address the failure. Company Z must send the participant a correction notice no later than December 15, 2024 (45 days after the deadline to begin the correct withholding).
The only distinction between being actively employed and terminated is that the notice Company Z provides the participant does not have to include a statement that deductions have or will begin shortly, and the notice is not required to include an explanation that the participant may increase future deferral elections to make up for the MDO.
Example 2 – Facts:
Same facts as in Example 1 except the participant is not terminated
Company Z provides a matching contribution equal to 100% up to 3% of eligible compensation
Automatic enrollment is set at 3%
Company Z must start the 3% automatic enrollment withholding for the participant no later than the October 31, 2024 pay date and must provide the participant a notice no later than December 15, 2024. There is no QNEC required because the correction is occurring by the end of the 9.5-month following the end of the plan year period; however, the participant is owed the 3% of eligible compensation match from the date of the failure (January 1, 2023) through the date of the correction (October 15, 2024). The match must be adjusted for earnings. *The match plus earnings must be provided regardless of whether the participant is active or terminated.
Company Z must deposit the match within 6 months of the correct deferrals beginning, so in this example, the deadline to deposit the corrective match owed the participant is April 30, 2025.
MDO Quick Reference Charts:
Plan Sponsor Must Document Corrections
Simply making the corrections to the plan accounts of the participants who experience MDOs and/or making additional employer contributions (and the required 45-day notice, where applicable) is not enough to satisfy the requirements of self-correction. It is as important to document the correction process in case the plan is subsequently selected for audit by the IRS. The following is a checklist of items that should be included in the memo and retained in the plan’s permanent records:
What was the failure (i.e., Missed Deferral Opportunity)
Dates the error(s) occurred (specific payroll dates and plan years)
How many participants were affected
Method used to correct the failure and how earnings were determined
How did the failure occur and when was it fully corrected
Discuss changes to your existing practices and procedures that will be made to prevent the error from reoccurring
Having documentation in the plan’s records will be beneficial upon audit by the IRS and when you are completing the plan’s annual Form 5500 audit. The plan’s CPA will thank you!
Conclusion
Recognizing that missed deferral errors are common mistakes in 401(k)/403(b) plans, the IRS has provided a somewhat user friendly “how to guide” on methods to correct the errors when they are discovered. While this post presents a high-level overview of the correction methods applicable to different situations, it is highly recommended that plan sponsors consult with a subject-matter expert to assist with missed deferral opportunity corrections process. The good news is that Secure 2.0 has made the ability to self-correct plan errors continues permanent, the options for reduced corrections continue to be expanded, and this subject-matter expert is excited for the impending updates to EPCRS expected to be released at the end of December 2024.
Newfront Retirement Services understands the complexity of maintaining and operating a compliant retirement plan program. If you find that you need a subject-matter expert – feel free to contact me or just connect to keep up to date on regulatory updates: Joni_LinkedIn
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