PSNC 2017: Fixing Your Mistakes—Correcting the Most Common Plan Errors

No one is perfect, not even plan sponsors. Mistakes will be made.

Speaking at the 2017 PLANSPONSOR National Conference, in Washington, D.C., Tami Guimelli, assistant vice president, Employee Retirement Income Security Act (ERISA) attorney, benefits consulting group at John Hancock Retirement Plan Services, discussed common plan mistakes and how to navigate the regulators’ various correction programs.

Guimelli explained that the self-correction program (SCP) is part of the Internal Revenue Service (IRS)’ Employee Plans Compliance Resolution System (EPCRS) and allows plan sponsors to correct operational plan failures. The voluntary correction program (VCP) covers operational failures, but also demographic failures and plan document failures.

There is a fee involved with the VCP. Plan sponsors file a formal submission process and pay a per-participant fee. Guimelli said the IRS will review the plan sponsor’s proposed correction and, hopefully, approve it and send the sponsor a compliance letter. The sponsor will have 150 days to fix the error.

The closing agreement program (CAP) is the most expensive IRS correction program, but sometimes the fee can be negotiated down. An error that would require the CAP could be one the IRS finds during an examination of the plan; it would disqualify the plan and make it and participant contributions subject to taxation.

Guimelli noted it is easier to fix a problem before the IRS finds it.

There is a difference between a significant and insignificant failure. Guimelli explained that the determination is based on facts and circumstances—whether it is a one-time or recurring error, how many participants it affects, how much in plan assets is affected, and how long the error has existed. She said, if the error has been going on for two years or less, it could be considered insignificant. If it is insignificant, it can be fixed at any time, even if the plan is under audit.

If the error is significant, though, the plan sponsor must correct it no later than the end of the second plan year following the failure. For example, Guimelli said, if a plan failed actual deferral percentage and actual contribution percentage (ADP/ACP) testing and didn’t fix the testing failure by the end of the following year, that’s when the two-year-period correction program under the IRS EPCRS would start.

Elective deferral failures are common in defined contribution (DC) plans, Guimelli told conference attendees. For instance, a participant’s deferrals weren’t started, a participant wasn’t informed of eligibility to defer, or deferrals started at the wrong rate. She said, under new guidance, if the plan is an automatic enrollment plan and a participant’s deferral was missed or started at the wrong amount, and if the error was discovered within 9½ months after the year of failure, the plan sponsor may correct it under the VSP.

Guimelli explained that, before, the plan sponsor would have had to restore missed contributions to the participant’s account, but under the new guidance the sponsor has to restore only the missed employer match on deferrals plus earnings, and it can use the return ratio of the default investment in the plan to calculate earnings. If the error is discovered after 9½ months, the employer may correct within a two-year period, but the plan sponsor needs to make a 25%-of-salary qualified nonelective contribution (QNEC) to compensate for the missed deferral. If the error isn’t corrected within the two-year period, the QNEC becomes 50%.

For plans not using auto-enrollment, the error can be corrected within three months by contributing the missed match plus earnings. If after three months, but within two years, the plan sponsor must also make a 25% QNEC. If after two years, the QNEC rises to 50%.

The plan sponsor must provide a notice to participants affected by such errors, saying the correct deferral wasn’t implemented on time but the plan sponsor has restored the missed match with earnings to the account and started elective deferrals, Guimelli said. The notice must also provide the participant with the phone number of someone to contact, with any questions.

“The goal of all corrections is to put participants in the position they would have been in if the error wasn’t made at all,” Guimelli said.

Other than enrollment errors, Guimelli said, other common errors are:

• The vesting was wrong on a participant’s account, and it wasn’t discovered until after a distribution was made;
• The matching contribution changed, but it wasn’t communicated, so the wrong match was made. If the error is that the plan sponsor failed to make an employer contribution, the VCP should be used, and if the wrong amount was applied to a participant’s account, the SCP should be used; and
• The wrong definition of compensation was used, resulting in an excess deferral by the participant. In that case, the plan sponsor should return the excess to the participant and forfeit the match.

According to Guimelli, a less frequent error is allowing an employee to defer before he is eligible. In that case, the plan sponsor may make a retroactive plan amendment to allow the employee to participate. “The same can be true if the plan sponsor permitted a hardship withdrawal or loan and didn’t have a hardship or loan provision in the plan,” she said.

According to Guimelli, the late deposit of contributions or loan repayments falls under the Department of Labor (DOL)’s voluntary fiduciary correction program (VFCP) because it is a fiduciary breach. Anything that is a fiduciary breach, such as misuse of plan assets, falls under this program.

One common error the DOL focuses on is remittance of contributions and loan repayments within a less than reasonable time period. Guimelli warns that if you have always remitted within five days, you may not switch to seven days.

Sometimes this is outside the plan sponsor’s control, so she suggests that plan sponsors have good procedures and open communication, also that they check with the payroll provider to see when contributions and loan repayments will be deposited.

Guimelli offered these additional helpful suggestions:

• Identify what type of mistake was made and which program can be used to correct it;
• Review the plan document and procedures on an annual basis. Make sure you are operating correctly per the document, and check to see if there was an amendment and whether it was circulated to everyone, including your payroll provider and recordkeeper; and
• Have formal procedures in place.

Guimelli stresses that set procedures are important if someone else needs to take on the job and must get up to speed quickly. Also, if a plan sponsor uses a correction program or if the sponsor is audited, it must show there are procedures in place. If a significant failure has occurred and the plan sponsor is involved in an IRS audit, such procedures will help, she said.

“Don’t be afraid to find mistakes and correct them. The IRS really wants people to correct their plans and not have to disqualify the plan. The Revenue Procedure regarding corrections is long, but you will be able to find your particular error and correct it,” Guimelli concluded.