Industry research increasingly points to the positive benefits of both 401(k) automatic enrollment and automatic escalation features in 401(k) plans1. Behavioral economists have demonstrated that implementing these programs result in higher participation rates and higher rates of participant deferrals2.
Yet at the same time, some 401(k) plan sponsors have hesitated because of perceived harsh consequences for the mistakes referred to officially as “elective deferral failures”. An elective deferral failure happens when a plan sponsor fails to properly implement deferrals either that participants elect to make (affirmative elections) or those based on automatic features of the plans including automatic escalation.
Last year, the IRS updated its Employee Plans Compliance Resolution System (EPCRS) and released Revenue Procedure 2015-283 to address these issues. We wanted to review this relatively new rule because of its timeliness as more and more plan sponsors consider automatic features.
Correction Rules Were Previously Costly
Prior to Revenue Procedure 2015-28, the rules to correct errors tended to overcompensate participants when these failures lasted over short periods. The cost to the plan sponsor of a missed deferral opportunity was generally 50 percent of the missed deferral. Costs varied based on the type of failure:
- Improperly excluded employees – A plan sponsor who failed to include an employee faced a missed deferral cost of 50 percent of the missed deferral based on the actual deferral percentage for the group the employee is in (highly compensated vs non highly compensated)
- Safe harbor 401k plans faced missed deferral cost of 50 percent of a 3 percent deferral. Enhanced match safe harbor plans faced 50% of the percentage that receives a dollar-for-dollar match.
- Failure to implement a salary deferral election faced 50 percent of the amount the employee elected.
- Failure to automatically enroll a participant faced a deferral cost of 50 percent of the elected deferral percentage.
Corrections for automatic contributions arrangements were also extremely costly and discouraged plan sponsors from adopting these automatic contribution arrangements that make it easier for participants to save.
New Methods
Rev. Proc. 2015-28 offers three new methods to correct elective deferral failures:
- For failed automatic enrollment or increase (escalation), there will no longer be a missed deferral cost provided the failures are found and corrected by the first payroll date after the earlier of: nine and ½ months after the end of the plan year or the last day of the month of the month following the plan sponsor’s notification of the problem.
- For plan sponsors who fail to implement an affirmative election, automatic enrollment, or automatic increase, there is no corrective contribution required for missed deferrals that happen within the prior three months if the deferrals are restarted by the earlier of three months after the missed deferrals occurred or the last day of the month following the month the employee notifies the sponsor of the error.
- The employer corrective contribution required for missed deferrals is reduced from 50 percent to 25 percent for those that fall outside the time periods in 1 and 2 above but are corrected by the last day of the second year following the plan year in which the error occurred.
Under all of these new corrective methods, the employer must also:
- Make a matching contribution in the amount the participant would have received had the deferrals been handled correctly;
- Provide notice to the affected participants within 45 days; and
- Calculate lost earnings for any corrective contributions the employer is required to make.
This guidance applies to errors that occur through December 31, 2020.
Buddy Horner, QKA, is senior manager, retirement consulting with Bronfman E.L. Rothschild.
Sources: Internal Revenue Service, McKay Hochman Company, Inc.
1 https://www.ebri.org/publications/ib/?fa=ibDisp&content_id=4495
2 http://www.bls.gov/opub/mlr/2015/article/automatic-enrollment-employer-match-rates-and-employee-compensation-in-401k-plans.htm
3 https://www.irs.gov/irb/2015-16_IRB/ar07.html
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
