Despite best efforts in administering 401(k) plans, sometimes mistakes are made. One of the most common mistakes is a failure to execute a participant’s election to defer. This can occur by missing a participant’s initial deferral election, not deferring on eligible compensation, or missing an increase in the deferral rate. In each case, it results in the participant receiving taxable compensation rather than contributions into their 401(k) accounts, as well as missed earnings. Luckily, the IRS allows corrections of these mistakes.
The correction is for the employer to make a corrective contribution of 50% of the missed deferral, adjusted for earnings on the participant’s behalf. The participant is fully vested in these contributions and they are treated the same as participant elective deferrals for distribution purposes. Consideration needs to be made if the participant is Highly Compensated, as a correction could cause the plan to fail the ADP testing. All plan and IRS limits needs to be considered as well. If the correction would bring the participant’s contribution over $19,500 for 2020, the correction should be reduced so that this limit is not exceeded, assuming the participant in not over the age of 50 and eligible for catch-up contributions.
Some examples of missed deferrals and the corrections:
- Participant A is currently deferring at 5% and elects in June to increase her deferral to 10%. This deferral was never processed, and she continued to defer at the 5% rate through the end of the year. The plan compensation for the missed deferral is determined to be $30,000. Her missed deferral amount is $1,500 and the correction is $750. In this assumption, the participant is not Highly Compensated and is not in danger of going over the IRS limit.
- Participant B is 38 years old and is currently deferring 20%. He has a base pay of $90,000 but received a bonus of $20,000 that was eligible plan compensation but did not have deferrals withheld. The missed deferral for Participant B is $4,000. The missed deferral amount for this participant is $2,000. However, as he already contributed $18,000 and is under the age of 50, the correction would be $1,500 for 2020.
In both of the above cases, the corrections are only for the missed deferrals. These corrective contributions must be adjusted as well for earnings on the missed deferrals. These are to be calculated from the date that the elected deferrals were to be made through the date of the corrective contribution. Consideration should also be given to any missed Company contributions, if applicable.
Lastly, determine why the deferrals were missed and put in place procedures to ensure that this does not reoccur. Click on the link for additional information about IRS correction programs and examples on how to correct issues with your plan.
Retirement plans can be very complex. As an innovative firm, Summit CPA specializes in 401(k) audits. We have the ability to offer assistance entirely off-site with little or no distraction to your daily office routine. We also offer flat-fee pricing so there are no surprises on your bill when the job is complete. For assistance contact our office at (866) 497-9761 to schedule an appointment.