The 11 most asked In-Service Distribution questions

An in-service withdrawal occurs when an employee takes a distribution from a qualified, employer-sponsored retirement plan, such as a 401(k) account, without leaving the employ of their company.  Read the 11 FAQs below to ensure you are informed on these distributions next time you are asked.

  1. When can a participant receive a distribution from a retirement plan while still working?

It depends. A plan may (but is not required to) allow participants to receive in-service distributions. In addition, certain conditions must be satisfied which are set forth under the Internal Revenue Code and regulations.

  1. Are the rules different depending upon the type of contributions?

Yes. Elective deferrals (i.e. 401(k) and Roth contributions) can only be distributed while a participant is still working under limited circumstances. The following in-service distributions are permissible, if provided for under the plan document:

  • Hardship distributions
  • Distributions on or after the date a participant has attained age 59 ½
  • Qualified reservist distributions
  • Distributions after a participant has become disabled (as defined under the terms of the plan)

Safe harbor nonelective and matching contributions may only be distributed upon reaching age 59 ½, hardship or disability. This also holds true for QNEC and QMAC account balances.

Profit sharing and employer matching contribution account balances may be distributed upon attainment of a stated aged (which may be less than age 59 ½), after the contributions have accumulated (or “aged”) in the plan for at least 2 years, after an employee has been a plan participant for at least 5 years, or upon a stated event.

Rollover and voluntary after-tax (non-Roth) contribution account balances may be distributed at any time.

Different rules apply to pension plan balances, which generally may not be distributed to an active employee prior to attainment of age 62.

  1. Are in-service distributions eligible for rollover?

Generally, yes. With the exception of hardship distributions, any of the in-service distributions described above are eligible for rollover.

  1. Are in-service distributions subject to the additional 10% income tax for early withdrawals?

Yes. Unless the participant has attained age 59 ½, the taxable portion of the distribution is generally subject to the additional 10% income tax. There are exceptions to this rule if the participant is disabled (as defined under the Internal Revenue Code) or if the distribution is a qualified reservist distribution.

  1. What qualifies as a “hardship” distribution?

The regulations provide “safe harbor” rules, which most plans follow. Under these rules, hardship distributions may be made for the following reasons:

  • To prevent foreclosure or eviction from a participant’s principle residence
  • To purchase a participant’s principal residence (excluding mortgage payments)
  • To pay for post-secondary education for a participant, his spouse, children or dependents for the next 12 months
  • To pay for unreimbursed medical expenses that would otherwise be deductible (without consideration to the deduction limit) for a participant, his spouse, children or dependents
  • To pay for funeral expenses for a participant’s deceased parent, spouse, child or dependent
  • To pay for expenses necessary to repair a participant’s principle residence as a result of a casualty
  • Expenses incurred as a result of a natural disaster in a federally declared disaster area
  • Medical, post-secondary educational, and funeral expenses for a participant’s primary beneficiary
  1. Are in-service distributions from Roth accounts taxable?

It depends. Roth contributions are not taxed when distributed, but the related earnings may be unless the distribution is a “qualified distribution”. In general, a distribution is a qualified distribution only if the distribution is being made on account of death, disability or attainment of age 59 ½ and the participant has had a Roth account under the plan for at least 5 years.

Distributions that are rolled over to a Roth IRA are not taxable.

  1. What are “Qualified Reservist” distributions?

A plan can allow participants who have been called to active duty for a period of more than 179 days (or indefinitely) to receive a distribution of their elective deferrals.

  1. Are distributions from voluntary after-tax accounts taxable?

Like Roth contribution account balances, the after-tax contribution portion of the account is not taxable but the related earnings are unless the distribution is rolled over to a traditional IRA. If rolled over to a Roth IRA, the related earnings are taxed.

  1. If a plan allows in-service distributions, can the provisions be removed?

A plan can remove a hardship distribution feature at any time; it is not a protected benefit. The other types of in-service distribution options discussed above are protected under the law. What this means is that any of these provisions may be removed prospectively; however, the participant account balances as of the effective date of the change must continue to be eligible for in-service distribution under the plan’s prior provisions.

  1. If an employee terminates and then is rehired, can he still receive a “termination” distribution?

No. After an employee has been rehired, he or she is no longer eligible to receive a termination distribution and would have to qualify for an in-service distribution under the terms of the plan.

  1. What happens if a plan issues an in-service distribution to a participant who doesn’t qualify to receive one under the terms of the plan?

The bottom line is that the plan sponsor must take corrective actions; this is plan qualification issue. The good news is the IRS provides methods for correcting such mistakes under their Employee Plans Compliance Resolution System (EPCRS). Generally, the employer must take steps to have the participant return the funds to the plan, along with related earnings, but there are other options as well.

To learn more about in-service distributions, please contact us and we will be happy to assist you.

What does it mean to be top-heavy?

In general, a plan is considered to be top-heavy when more than 60% of plan assets are attributable to “key employees” as of the “determination date”. Top-heavy plans are subject to certain minimum contribution and vesting requirements.

Who is a key employee?

A key employee is an employee who at any time during the plan year: (1) owned more than 5% of the company, (2) owned more than 1% of the company and had compensation in excess of $150,000, or (3) was an officer of the company with compensation in excess of a specified dollar amount ($180,000 for 2019). Note that stock attribution rules apply when determining ownership for this purpose.

What is the determination date?

For the first plan year, the determination date is the last day of the plan year. For subsequent years, the determination date is the last day of the prior plan year. Note that top-heavy status is measured annually and may change from year to year.

How is top-heavy status calculated?

The top-heavy ratio is calculated by comparing the account balances of key employees to non-key employees, after making certain adjustments. First, certain participant balances are excluded (i.e. rollover account balances from unrelated employers; account balances of terminated participants who did not work for the company during the year; and account balances of former key employees). Next, certain amounts are added back (i.e. distributions made on account of termination, death or retirement if the participant worked for the company during the year; and in-service distributions made within the 5-year period ending on the last day of the plan year).

 What are the minimum contribution requirements for top-heavy plans?

Generally, the employer must make a contribution on behalf of all non-key participants who were employed on the last day of the plan year equal to the lesser of 3% or the highest contribution rate of any key employee. Certain contributions count towards satisfying the top-heavy minimum requirement (e.g. employer matching contributions, profit sharing contributions, and forfeiture allocations). If a participant has already received an amount sufficient to satisfy the top-heavy minimum, no additional contributions must be made on their behalf.

Caution: Plans that allow for immediate entry for 401(k)/Roth purposes but have a longer eligibility period for employer contributions are still required to make top-heavy minimums for non-key participants who were only eligible for the 401(k)/Roth portion of the plan.

How is the highest contribution rate for key employees determined?

All contributions (other than rollover contributions) are considered when calculating the contribution rates for key employees. This means that 401(k) deferrals and Roth contributions are included.

What are the minimum vesting requirements?

Top-heavy plans must use either a 3-year cliff or 6-year graded vesting schedule. This requirement has little impact since most plans use vesting schedules that meet or exceed these standards.

Are safe harbor 401(k) plans exempt?

Safe harbor plans are generally not required to make top-heavy minimums if all non-highly compensated employees are eligible for the safe harbor contribution, and the employer makes no contributions to the plan other than (1) safe harbor matching contributions, (2) additional matching contributions that satisfy the safe harbor rules, or (3) safe harbor nonelective contributions.

Caution: Forfeiture allocations can trigger top-heavy minimums in safe harbor plans.

What happens if the employer doesn’t fund top-heavy minimums?

Failure to make top-heavy minimums is an operational failure that can jeopardize the qualified status of the plan. As a result, any “missed” top-heavy minimums must be funded along with related earnings.

If you have any questions regarding the top-heavy rules or would like to learn more, please contact us.


Most Common Mistake: Failure of Timely 401(k) Deposits

One of the most common mistakes made by 401(k) plan sponsors is failure to deposit participant contributions (i.e. 401(k) deferrals/Roth contributions) and loan payments in a timely manner. Having said that, it is worthwhile reviewing the rules and consequences of making late deposits.

What are the rules?

In general, the Department of Labor (DOL) requires that participant contributions and loan payments be deposited as soon as the amounts can be reasonably segregated from the general assets of the employer.  This is because the amounts are considered to become plan assets at this point in time. Under examinations, the DOL also reviews deposits for consistency to determine whether contributions were funded in a timely manner.

Safe Harbor for Sponsors of Small Plans

Under the regulations, there is a “safe harbor” for sponsors of small plans (generally, plans with less than 100 participants). Under this rule, participant contributions and loan payments will be deemed to have been funded in a timely manner provided that the contributions are deposited within seven business days following the date in which the amounts were withheld.

Sponsors of Large Plans

Since the 7-business day rule does not apply to large plans, these plan sponsors must abide by the general rule of making the deposits as soon as the amounts withheld can be reasonably segregated from the general assets of the employer. As a result, we generally recommend these employers make deposits within three business days on a consistent basis.

What are the consequences of making late deposits?

The employer has engaged in a prohibited transaction with the plan because the employer had “use” of plan assets.

  • The late deposit must be reported on Form 5500
  • The employer must pay a 15% excise tax on the amount involved by filing Form 5330
  • Participants must be credited with lost earnings (the DOL has an online calculator that may be used for this purpose in certain situations)

Is the employer required to file under the DOL’s Voluntary Fiduciary Correction Program (VFCP)?

No. Filing under VFCP is not required. Nevertheless, employers may want to file under this program to obtain relief from the DOL for penalties that may otherwise be imposed and agreement not to investigate the plan fiduciaries for failure to deposit the amounts in a timely manner.

If you have any questions regarding the deposit rules or would like to learn more, please contact us.

IRS Expands Self-Correction Programs

On April 19, 2019, the IRS issued guidance expanding the circumstances under which plan sponsors can make corrections for certain plan failures under the Employee Plans Compliance Resolution System (EPCRS) without seeking IRS approval. This is welcome relief since filing under the Voluntary Correction Program (VCP) can be costly, especially for small employers.

What changed?

The new guidance expands the corrections that can be made under the Self-Correction Program (SCP) by permitting corrections for certain plan loan, operational and plan document failures which could previously only be made by filing an application under the VCP. Since the IRS User Fees on the VCP Filings increased substantially last year, filing a VCP Application can be a costly process.

Plan Loan Failures

Plan loan failures are common and often occur when an employer fails to withhold loan payments from an employee’s paycheck. If the payments are not caught up within a specific time frame (known as the “cure period”), the loan is defaulted and the outstanding loan balance is taxed to the participant.

Previously, if the mistake was found after the expiration of the plan’s cure period, the only way to make the correction (and avoid taxation to the participant) was to file under VCP. This could be quite costly, since the VCP filing fees are based on plan assets (and not the failure itself). For example, if a plan sponsor needed to make corrections for three participants and the plan had $1,000,000 in assets, the VCP filing fee would be $3,000 (not including service provider fees to prepare the filing).

Under the updated procedures, a plan sponsor is permitted to make the correction for a loan that has gone into default under SCP assuming certain conditions are satisfied. The correction methods, however, remain unchanged. In general, a defaulted loan can be corrected by (1) having the participant make a lump-sum payment for the late loan payments, including accrued interest; (2) reamortizing the outstanding loan balance, including accrued interest, over the remaining term of the loan; or (3) a combination of both methods.

Note: In order to correct a defaulted loan (under SCP or VCP), the maximum 5-year repayment term (or longer period in the case of a home loan) must not have expired.

The new procedures also provide additional correction options for other types of plan loan failures.

Operational Failures

An “operational failure” is simply defined as a failure to follow the terms of the plan document. Many plan mistakes fall within this category. While most operational failures were previously eligible to be corrected under SCP (assuming the timing and general requirements were satisfied), there were only limited and specific circumstances under which corrections could be made by amending a plan retroactively to conform its terms to the plan’s prior operations.

For example, if plan operationally allowed all participants to make Roth contributions (without amending the plan to permit Roth contributions), a VCP filing would have been required to amend the plan retroactively to correct the mistake. Under the new guidance, this generally could be done under SCP.

These changes should give plan sponsors much greater flexibility in making necessary plan corrections, since the rules have been relaxed for retroactive amendments used to correct operational failures. This doesn’t mean that any operational failure can be made by retroactive amendment under SCP, though. The IRS did impose specific restrictions, but this is still a huge win!

Plan Document Failures

Plan document failures happen when a plan contains a provision (or provisions) that, at face value, is not permissible under the Code or regulations. They also happen when a plan fails to adopt a required plan amendment (or document restatement). Previously, such corrections could only be made under VCP. Under the updated guidance, plan sponsors are now permitted to make the necessary corrections under SCP provided the corrections are made within a specific time frame and other conditions can be met.

The Bottom Line

Mistakes happen; the rules governing retirement plans are complex. This new guidance is great news for plan sponsors, making it much easier for them to work with their plan service providers to correct certain failures without a costly VCP filing.

To have questions answered about these new rules, please contact us.

Should your clients add a Safe Harbor 401(k) provision?

If your client has a traditional 401(k) plan that failed the 2019 ADP/ACP testing, it may be the perfect time to discuss the option of adding a safe harbor provision to the plan.  The following provides a general overview of the rules applicable to safe harbor 401(k) plans.

What is a Safe Harbor 401(k) plan?

A safe harbor 401(k) plan is a type of retirement plan that is exempt from certain testing requirements. Specifically, a safe harbor plan is generally exempt from ADP/ACP testing enabling the plan’s highly compensated employees to maximize 401(k) deferrals/Roth contributions without limitation. Safe harbor plans may also be exempt from top-heavy requirements if certain conditions are met.

What are the contribution requirements?

The plan must make either a safe harbor non-elective contribution or safe harbor matching contribution. These contributions cannot be subject to allocation conditions, e.g. employment on the last day of the plan year and/or 1,000 hours, and must be:

  • 100% vested
  • Subject to the same distribution restrictions as 401(k) contributions

What is a safe harbor non-elective contribution?

A safe harbor non-elective contribution is similar to a profit sharing contribution and must be made on behalf of all eligible employees, with limited exceptions. The contribution must be, at a minimum, 3% of eligible plan compensation regardless of whether the employee elects to defer or is employed on the last day of the plan year. The SECURE Act of 2019 made changes to this plan design that allow a Plan Sponsor to add this provision at any time during the Plan Year, or even after the end of the Plan Year up until the due date of their tax return. Adding the provision after the 11th month of the Plan Year would require a 4% contribution rather than 3%, but that can drop back down to 3% for future years.

What is the formula for safe harbor matching contributions?

Unlike the safe harbor non-elective, the safe harbor matching contribution can only be added at the beginning of a Plan Year.

There are two basic formulas that may be used:

  • 100% on the first 3% of salary deferred, plus 50% on the next 2% of salary deferred (maximum of 4% match)
  • 100% on at least the first 4% of salary deferred, but no more that 6% of salary deferred

Are there other requirements?

Yes, but only for the safe harbor matching contribution; before the beginning of each plan year the employer must provide all eligible employees with a notice meeting specific requirements. The notice must also be provided to employees before they become eligible to participant in the plan on an ongoing basis throughout the year.

Can a plan make matching contributions in addition to safe harbor matching contributions?

Yes, however, depending upon the matching formula, ACP testing may be required.

If the plan allows for after-tax (non-Roth) contributions, is the plan still exempt from ACP testing?

No; voluntary after-tax contributions are always subject to ACP testing.

For additional matching contributions to be exempt from ACP testing, what conditions must be satisfied?

  • Discretionary matching contributions may not exceed 4% of compensation
  • Deferrals in excess of 6% may not be matched
  • The rate of match may not increase as deferrals increase
  • The plan may not impose allocation conditions on additional matching contributions

In order for the plan to be exempt from the top-heavy rules, what conditions must be satisfied?

  • No contributions may be allocated to participants for the plan year other than 401(k), Roth and safe harbor contributions
  • Forfeitures may not be allocated to participant accounts for the plan year
  • The plan may not have dual eligibility requirements, e.g. immediate eligibility for 401(k) and a one-year wait for safe harbor contributions

Can a safe harbor plan include an automatic enrollment feature?

Yes; as a matter a fact, a safe harbor plan can be designed in such a way that if it includes an automatic enrollment feature with an automatic escalation feature, the plan can take advantage of a lesser safe harbor matching contribution formula and a 2-year cliff vesting schedule.

Can a safe harbor plan provide profit sharing contributions?

Absolutely! The plan can provide for discretionary (or fixed) profit sharing contributions in addition to safe harbor contributions and can include any allowable allocation formula, such as an integrated or cross-tested formula. This just means the plan will not be exempt from the top-heavy rules in years in which the employer elects to make a profit sharing contribution.

When can a plan adopt safe harbor provisions?

An existing 401(k) plan can only adopt a Safe harbor Matching Contribution feature effective as of the beginning of a plan year. Different rules apply to profit sharing only and new plans.

How can I learn more?

If you would like to learn more about safe harbor plans, please contact us. We would be happy to assist you with determining whether this type of design would be a good fit for any of your retirement plan clients.


Loans and Termination of Employment

When a participant terminates employment, what happens to their loan balance?

Most plans provide that the loan becomes payable in full upon termination of employment. If the loan is not repaid within a specified amount of time, the loan is “offset”. What this means is the outstanding loan balance is treated as being distributed from the plan to the participant.

A plan can, however, permit a participant to continue to make regularly scheduled loan payments after termination employment, so you will want to check the plan document and loan policy to determine which provisions apply.

Is a loan that has been offset taxed?

A loan that has been offset (which is an actual distribution) is taxable to the participant. Further, it is subject to the 10% early withdrawal penalty unless an exception applies.

To avoid taxation, a participant can rollover the dollar amount of the loan balance that was offset to an IRA or other qualified plan (assuming the plan accepts such rollovers).

How long does a participant have to complete the rollover?

Effective January 1, 2018, a participant has until the extended due date of his or her individual income tax return (for the year the loan was offset) to complete the rollover.

It is important to note this extended rollover period only applies to the loan offset amount; the normal 60-day rollover window applies to any cash distributions.

Is the loan offset amount subject to 20% federal withholding?

It depends. If the participant receives a cash distribution, the outstanding loan balance is included when determining the 20% withholding requirement. If the participant doesn’t take a cash distribution, then withholding would not apply.

Can a participant rollover their actual loan balance to another employer’s plan?

Possibly. Assuming the loan has not been offset, it would be permissible to rollover the loan itself from one plan to another if permitted under the terms of both plans. However, this is not a very common feature.

What if a plan is terminated?

Generally, the rules described above also apply when a plan is terminated.

How can I learn more?

If you would like to learn more about these rules, please contact us.

Fidelity Bonds for Your Retirement Plan

Under the Department of Labor (DOL) regulations, your retirement plan will need to maintain an ERISA Fidelity Bond. A fidelity bond protects the assets in the plan from misuse or misappropriation by the plan fiduciaries. Plan fiduciaries include the plan trustees and any person who has control over the management of the plan and its assets.

Required ERISA Fidelity Bond Amount

At the very least, the bond must be equal to 10% of the value of the total plan assets, with a minimum bond value of $1,000 and a maximum bond value of $500,000. For the first year, the bond amount will be based on the estimated amount of assets that will be handled by the plan for the year.

If you have non-qualifying assets more than 5% of the total plan assets, additional requirements apply. Non-qualifying assets are those assets not readily tradable on a recognized exchange. These may include limited partnerships, artwork, collectibles, mortgages, real estate, securities of closely-held companies and other assets held outside of regulated institutions such as a bank; an insurance company; a registered broker-dealer or other organization authorized to act as custodian for retirement accounts. Non-qualifying assets require additional bond coverage equal to 100% of these assets or could subject a plan to obtain a full-scope audit, where an independent CPA physically confirms the existence of the assets at the start and end of each Plan Year.

Why do I need an Erisa Fidelity Bond?

There are serious consequences for not purchasing and maintaining a sufficient ERISA fidelity bond. Not having this required coverage can be a red flag to the Department of Labor that they need to take a closer look at the plan. You are not only at risk for a DOL audit, but there are citations associated with not having this required coverage.

How do I obtain an Erisa Fidelity Bond?

As a convenience to you, EJReynolds has partnered with Colonial Surety Company, a national online insurance company that is U.S. Treasury listed and licensed in all states and territories. As experts in all aspects of ERISA regulations, Colonial Surety Company will ensure that you are properly bonded and that your bond is renewed prior to expiration so that your plan remains in compliance.

You can easily obtain an ERISA Fidelity Bond for your plan at:

Or, contact EJReynold and we’ll connect you with one of our expert ERISA Bond partners.

What you need to know about Required Minimum Distributions (RMD)

What are Required Minimum Distributions?

Required Minimum Distributions (RMDs) are minimum payments that must be made to participants in qualified plans and to owners of IRAs on an annual basis after an individual has attained a certain age.

When must RMDs begin in a qualified retirement plan?

In general, RMDs must begin no later than April 1st following the calendar year in which the participant attains age 70 ½ or retires.

RMDs must commence, however, for “5-percent” owners no later than April 1st following the calendar year in which the participant attains age 70 ½ even if the owner is still actively employed.

A plan may, but is not required to, require RMDs begin for all participants (owners and non-owners) no later than April 1st following the calendar year in which the participant attains age 70 ½ (but most plans don’t).

For example, a non-owner participant turns 70 ½ on July 1, 2018 and retires on July 31, 2018. His first RMD is due for 2018 but may be made as late as April 1, 2019. If he elects to take his first RMD in 2019, then he will be required to receive two RMDs in 2019 (one for the 2018 calendar year and one for 2019).

What is a “5-percent” owner?

Generally, a “5-percent owner” is any individual who owns more than a 5% interest in the company, and certain family members of 5-percent owners.

Do the same rules apply to IRAs?

Not exactly; the exception discussed above for non-owners does not apply to traditional IRAs. RMDs must commence no later than April 1st following the calendar year in which the IRA owner attains age 70 ½.

Note: Roth IRAs are not subject to the RMD rules until after the death of the IRA owner.

What is the due date for RMDs?

After the first year (when the distribution must be made by the following April 1st), RMDs from a defined contribution or 401(k) plan must be made each year by December 31st. For a defined benefit plan, including cash balance plans, the RMD must be calculated and distributed as of April 1steach year.

Note:It is important to remember that most plan recordkeepers and IRA custodians need time to process distributions. A good third party administrator will make sure the plan sponsor is aware of any RMDs that must be made so that they can be issued in a timely manner.

For IRAs, the owner should make sure he or she communicates with his or her IRA custodian so that there is ample time to process the necessary distribution.

Correcting Mistakes in 401(k) Plans

According to the IRS*, some of the most common mistakes made in 401(k) plans include:

  • Failure to include or exclude certain types of compensation for contribution purposes
  • Failure to include eligible employees and/or exclude ineligible employees
  • Failure to withhold loan payments resulting in defaulted participant loans
  • Failure to make required top-heavy minimum contributions

The good news is that most of these mistakes can be corrected through the self-correction procedures set forth under the Internal Revenue Service’s Employee Plans Compliance Resolution System (EPCRS)!

Overview of EPCRS

The purpose of EPCRS is to allow plan sponsors to correct plan defects and protect the qualified status of their plans. EPCRS includes three programs:

  • Self-Correction Program (SCP)– This program allows plan sponsors to self-correct certain defects without having to go to the IRS for approval.
  • Voluntary Correction Program (VCP)– This program allows plan sponsors to correct failures by filing for approval with the IRS. Certain defects must be corrected under this program, and there are fees associated with the filing.
  • Audit Closing Agreement Program (Audit CAP)– This program is available for failures that are discovered during examination that have not been corrected under SCP or VCP. Although the plan sponsor can still make corrections, the IRS will impose sanctions.

General Correction Principles

Regardless of the program used, there are basic principles that govern all corrections:

  • Corrections should restore the plan and its participants to the position they would have been had the failure not occurred.
  • Corrections should be reasonable and appropriate for the error and should (1) be consistent with existing laws and regulations, (2) provide benefits in favor of non-highly compensated employees, and (3) retain assets in the plan.
  • There generally should be a full correction for all plan years.
  • The correction generally must include related earnings.

In addition, EPCRS includes correction methods for certain plan failures that are deemed to be reasonable and appropriate provided that the corrections are made in accordance with the prescribed methods.

Types of Plan Qualification Failures

EPCRS categorizes plan defects as follows:

  • Operational Failures– A failure to follow the terms of the plan. Most mistakes fall in this category and can be corrected through the self-correction program as long as they are discovered in time (see below).
  • Plan Document Failures– A failure that occurs because one or more plan provisions (or absence of provisions) violate the requirements of the Internal Revenue Code (e.g. failure to adopt required plan amendments in a timely manner).
  • Demographic Failures– A coverage or nondiscrimination testing failure that is not an operational failure. Generally, these failures must be corrected by amending the plan to provide for additional benefits on behalf of non-highly compensated employees.
  • Employer Eligibility Failures– Adoption of a 401(k) plan by an employer that fails to meet the employer eligibility requirements to sponsor a 401(k) plan.

Note: The self-correction program is not available for plan document, demographic, or employer eligibility failures.

General Rules for the Self-Correction Program
In general, insignificant operational failures may be corrected under SCP at any time; significant operational failures can only be corrected under SCP if they are completed (or substantially completed) by the last day of the second plan year following the plan year in which the error occurred. Corrections of significant failures that are made outside of the required timeframe must be completed through VCP. Whether a particular failure is significant is based on the relevant facts and circumstances.

Note: There are a limited number of operational failures that must be corrected under VCP (e.g. plan loan failures).

Correcting Mistakes
The rules governing retirement plans are complex and mistakes happen. Since the IRS can, and will, impose sanctions when failures are found during examination, it is always best to fix plan defects under SCP or VCP so that costly sanctions can be avoided!

To learn more about EPCRS and correcting plan failures, please contact us.

*Source:“EPCRS: Correcting Common 401(k) Mistakes”, July 25, 2013, IRS Phone Forum

ADP/ACP nondiscrimination Testing – What is it all about?

Since it’s time for most 401(k) plans to perform annual nondiscrimination testing, it makes sense to review the requirements for the ADP/ACP tests and the options for plans that fail one or both tests.

Note: Plans that provide for safe harbor matching or safe harbor nonelective contributions are generally deemed to satisfy both tests.

What are the ADP and ACP tests?

The ADP/ACP tests are performed to demonstrate that the plan does not discriminate in favor of highly compensated employees (HCEs) with respect to 401(k)/Roth deferrals and employer matching contributions. The ADP test compares the average deferral rates of the HCEs to that of the non-highly compensated employees (NHCEs); the ACP test does the same for matching contributions. Plans may use either the current year or prior year average of the NHCEs for this purpose; however, the method selected must be specified in the plan document.

In general, a plan passes these tests if the average of the HCEs does not exceed the lesser of (1) the NHCE average plus 2%, or (2) 2 times the average of the NHCEs.

Do catch-up contributions get counted in the ADP test?

No. If a participant makes catch-up contributions by either exceeding the statutory limit ($18,500 for 2018/$19,000 for 2019) or a plan-imposed limit, the amounts are excluded from the ADP test.

What happens if a plan fails these tests?

The plan sponsor must take corrective actions which typically involves issuing corrective distributions to certain HCEs. Although this is the most common way to correct failures, many plans also allow for the employer to make an additional contribution to the plan on behalf of certain NHCEs. These amounts, known as QNECs (Qualified Nonelective Contributions) and QMACs (Qualified Matching Contributions), must be 100% vested and are subject to certain distribution restrictions.

Note: It may be possible to correct or reduce the impact of an ADP testing failure by “reclassifying” deferrals of eligible HCEs as catch-up contributions. When this occurs, corrective distributions are reduced by the reclassified amounts to the extent they do not exceed the catch-up limit ($6,000 for 2018 and 2019).

Is there a deadline for correcting failures?

Yes. Generally, corrective distributions must be issued within 2 ½ months following the close of the plan year to avoid a 10% excise tax imposed on the excess amounts. Plan sponsors of 401(k) plans that include an “eligible automatic contribution arrangement” have up to 6 months to issue corrective distributions without incurring excise taxes.