We get it, errors can happen. If you notice an eligible employee(s) has been mistakenly excluded from being able to make contributions to your 401(k) plan, don’t worry, it can be fixed. Depending on the timing of the missed contributions and the type of contribution depends on how it will be corrected.
The first thing you need to do is ensure you have answers to these questions:
- What type of deferral opportunity was missed?
- Is there an employer match?
- Does the plan have have an auto enrollment feature?
- Is the plan a safe harbor plan?
- How long has the error occurred?
Your answers are important factors in determining the proper solution. You will need to follow these steps to rectify the situation:
- Calculate the missed match
- Calculate the missed earnings
- If necessary, calculate the corrective Qualified Non-Elective Contribution (QNEC) that replaces the “missed deferral opportunity”
- Provide written notice to the employee
Note: the QNEC is an employer contribution that is intended to replace the missed opportunity elective deferrals. The QNEC must be 100% vested and subject to the same distribution restrictions as elective deferrals.
When is a QNEC Required?
As we discussed above, the type of correction depends on when the error has been identified. A QNEC is not required if the missed deferral does not exceed three months and following two (2) conditions are met:
- Correct deferrals commence no later than the earlier of the first payment of compensation on or after the three month period, or the first payment of compensation made on or after the last day of the month that follows that in which the participant notifies the employer of the missed deferral.
- Notice of the failure is provided to affected employees no later than 45 days after the date the correct deferrals begin.
If the plan has automatic enrollment, there is no QNEC for a missed deferral if:
- Failure to implement automatic deferral does not extend beyond 9½ months after the plan year of failure
- Correct deferrals commence no later than the earlier of the first payment of compensation on or after a 9½ month period, or the first payment of compensation on or after the last day of the month after the month in which the participant notifies the employer of the missed deferral.
- The correction applies even for employees making an affirmative election.
- Notice of the failure is provided to affected employees no later than 45 days after the date correct deferrals begin.
- The plan makes up earnings and full match.
- There is a sunset of automatic enrollment missed deferral correction for failures after Dec. 31, 2020 (extended to 12/31/2023)
- If corrective deferrals start beyond 9 ½ months/or October 15 of the next plan year, a 25% QNEC is applicable; after the 3rd plan year in which the error occurred, a 50% QNEC is applicable
How to Calculate a QNEC
If you followed the steps above and determined a QNEC is necessary, the amount of the QNEC is equal to 50% of the employee’s missed deferral. This is determined by multiplying the actual deferral percentage for the employee’s group (HCE or NHCE) in the plan for the year of exclusion by the employee’s compensation for that year.
For failures found and fixed promptly, plan sponsors have the option to reduce the corrective QNEC contribution for the lost opportunity from 50% to 25% if all of the following conditions are met:
- The excluded employee must be currently employed by the employer at the time of correction
- The period of failure exceeds three months
- Correct deferrals begin by the first payment of compensation made on or after the earlier of:
- The last day of the second plan year after the plan year in which the failure first began for the affected employee, or
- The last day of the month after the month the affected eligible employee first notified the plan sponsor; and
- Within 45 days of being given the opportunity to make salary reduction contributions (or the commencement of auto-enrollment contributions)
Regardless of the rate of the corrective QNEC (0%, 25% or 50%), the company must calculate any missed matching contribution using 100% of the missed deferral opportunity amount.
It is important to note that if an employee is terminated prior to the date of the correction, a 50% QNEC penalty is automatically applied to the missed deferral opportunity, regardless of any of the above exceptions.
You must notify a participant in writing that there was a missed deferral opportunity. The Notice must include:
- An explanation of the failure
- The compensation period the deferrals were missed
- A statement that correct deferrals have begun or will begin
- A statement that a corrective allocation of the missed match will be made
- An explanation that the affected participant may increase the deferral percentage to make up the missed deferral, subject to plan and IRS limits
- Plan contact information (name, address, phone number, email address
The IRS also provides valuable information on missed deferral opportunities in their 401k Fix-It-Guide.
If you have additional questions, we’re always here to help.