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

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