errors and acceptable correction methodserrors and acceptable correction methods irs revenue...

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RSMH072 1

Errors and acceptable correction methods Revised May 2017

Error Index

Error Description

SCP and VCP

01 Failure to properly provide the minimum top-heavy benefit or contribution to non-key employees.

02 Failure to satisfy the ADP test, the ACP test, or, for plan years beginning on or before December 31, 2001, the multiple use test. [Option 1]

03 Failure to satisfy the ADP test, the ACP test, or, for plan years beginning on or before December 31, 2001, the multiple use test. [Option 2]

04 Failure to distribute elective deferrals in excess of the section 402(g) limit.

05 Employee elective deferral failure that does not exceed 3 months.

06 Employee elective deferral failure that extends beyond 3 months but not past the SCP Significant Failure Deadline.

07 Employee elective deferral failure to implement an automatic contribution feature (available until January 1, 2021)

08 Exclusion of an eligible employee from making elective deferrals or employee post-tax contributions, or from receiving matching contributions for one or more plan years.

09 Exclusion of an employee eligible to participate in a defined contribution plan from making elective deferrals or employee post-tax contributions, or from receiving matching contributions for less than one year.

10 Exclusion of an employee eligible to participate in a safe harbor 401(k) plan from making elective deferrals.

11 Failure to implement an employee election.

12 Exclusion of an eligible employee from a plan that permits designated Roth contributions.

13 Exclusion of an eligible employee to make catch-up contributions to a 401(k) plan.

14 Exclusion of an eligible employee from receiving a profit sharing contribution. [Option 1]

15 Exclusion of an eligible employee from receiving a profit sharing contribution. [Option 2]

16 Failure of a 403(b) plan to satisfy the universal availability rule.

17 Failure to timely pay the required minimum distribution (RMD) under section 401(a)(9).

18 Failure to obtain participant and/or spousal consent for a distribution subject to the participant and spousal consent rules.

19 Failure to satisfy the defined contribution annual additions limits for limitation years beginning before January 1, 2009.

20 Failure to satisfy the defined contribution annual additions limits for limitation years beginning on or after January 1, 2009.

21 Failure to satisfy the defined contribution annual additions limit with respect to an NHCE.


RSMH072 2

Errors and acceptable correction methods Rev. May 2017

Rev.

Error Index

Error Description

22 Failure to satisfy the defined contribution annual additions limit, where the portion of the excess attributable to matching and nonelective contributions has already been distributed.

23 Overpayments because of amounts paid in excess of the defined benefit annual benefit limit.

24 Vesting error in a defined contribution plan that results in forfeiture too large a portion of the employee’s account balance.

25

All overpayment errors, including distributions exceeding the employee’s or beneficiary’s benefit under the plan due to an error in applying the compensation limit ($200,000 as indexed), an error in forfeiting nonvested ACP excesses, or an error in forfeiting matching contributions attributable to Excess Amounts.

26 Allocation of contributions or forfeitures under a defined contribution plan based on compensation in excess of the compensation limit ($200,000 as indexed). [Option 1]

27 Allocation of contributions or forfeitures under a defined contribution plan based on compensation in excess of the compensation limit ($200,000 as indexed). [Option 2]

28 Hardship distributions made under a plan that does not allow hardship distributions or plan loans made under a plan that does not allow plan loans.

29 Inclusion of employee who has not met the plan’s minimum age or service requirement or who was included too soon due to an incorrect plan entry date.

VCP only

30 Employer eligibility error.

31 Loan amount exceeding the maximum permissible amount ($50,000/50% limit).

32 Loan repayment period exceeds the maximum permissible repayment period (5 years for a general purpose loan).

33 Loans that do not meet the level amortization requirements.

34 Loan default errors.


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Errors and acceptable correction methods

IRS Revenue Procedure 2016-51, which replaces and supersedes Revenue Procedure 2013-12, lists a number of errors that can be corrected under the various programs and some specific correction methods that are deemed acceptable to correct these errors. The list is only a sample of the errors that can be corrected under EPCRS. Many other types of errors commonly occur and can be corrected using EPCRS, but the IRS has not published specific correction methods. The list of correction methods below was created to give employers sponsoring qualified pension, profit sharing, stock bonus, and 403(b) plans guidance about acceptable correction methods for some of the most common errors and may be expanded as the IRS sees fit.

The errors listed can also be corrected using a method other than that described below. However, any other correction method must meet the General Correction Principles under EPCRS, and any employer interested in using an EPCRS program must meet that program’s eligibility requirements (see IRS Employee Plans Compliance Resolution System (EPCRS) Options).

Error Acceptable Correction Method Example

The following correction methods are available under both SCP and VCP.

1. Failure to properly provide the minimum top-heavy benefit or contribution to non-key employees.

Defined contribution plan: The plan sponsor must properly contribute and allocate the required top-heavy minimums to the plan in the manner provided for in the plan on behalf of the non-key employees (and any other employees required to receive top-heavy allocations under the plan). The corrective allocation must include lost earnings. Defined benefit plan: The non-key employees must accrue the minimum required benefit in the manner provided in the plan.

Employer A maintains only a profit sharing plan that provides for elective deferrals and nonelective contributions.

Employer A did not make a profit sharing contribution for 2005.

In 2007, Employer A discovers that the plan was top-heavy for 2005, and the Employer did not make the minimum required contribution.

In 2007, Employer A contributes the top-heavy minimum to the plan:

3% of compensation, adjusted for lost earnings, to each non-key individual employed on the last day of the 2005 plan year.

2. Failure to satisfy the ADP test, the ACP test, or, for plan years beginning on or before December 31, 2001, the multiple use test. [Option 1]

QNEC method: The plan sponsor must make qualified nonelective contributions (QNECs) to nonhighly compensated employees (NHCEs) to the extent necessary to raise the ADP or ACP of the NHCEs to the percentage needed to pass the test or tests. These contributions must:

Be made on behalf of all eligible NHCEs (to the extent that the Code section 415 limits on annual additions are not exceeded); and

Be the same percentage of compensation; and

Include lost earnings. Plan forfeitures may not be used to fund the QNECs.

Employer L maintains a 401(k) plan that uses the current year ADP testing method.

The plan does not provide for matching or after-tax contributions.

In 2007, it was discovered that testing for 2005 was performed incorrectly.

When rerun, the 2005 ADP test was not satisfied.

The 2005 HCE ADP was 9%.

The 2005 NHCE ADP was 4%.

The plan would not have passed the ADP test if the prior year method was used.

Employer L must make a QNEC to eligible NHCEs to raise the NHCE ADP to 7%.

https://www.irs.gov/pub/irs-drop/rp-16-51.pdf

http://www.retire.prudential.com/media/managed/2017-General_Correction_Principles.pdf

http://www.retire.prudential.com/media/managed/2017-General_Correction_Principles.pdf

http://www.retire.prudential.com/media/managed/2017-EPCRS_Options.pdf

http://www.retire.prudential.com/media/managed/2017-EPCRS_Options.pdf


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The plan sponsor does not have to match the QNECs made to satisfy the ADP test. However, employees who would have been eligible for a matching contribution if they had made elective deferral contributions must be counted as eligible employees for the ACP test, and the plan must satisfy the ACP test. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees to reduce the number of employees eligible to receive QNECs. Likewise, under this correction method, the plan may not be restructured into component plans (as permitted for plan years before January 1, 1992) to reduce the number of employees eligible to receive QNECs.

Employer L calculates the QNEC to be 3% of compensation for all eligible employees, giving the same percentage of compensation to each.

The amount allocated to each account includes lost earnings.

3. Failure to satisfy the ADP test, the ACP test, or, for plan years beginning on or before December 31, 2001, the multiple use test. [Option 2]

One-to-One method: The plan sponsor a) Distributes the excess amounts to the highly

compensated employees (HCEs), and b) Allocates an equal amount as a QNEC to the non-

highly compensated employees (NHCEs). The excess amount to be returned to an HCE is the sum of any excesses determined from the ADP, ACP and multiple use tests, adjusted for earnings through the date of the correction. Any amounts that were not vested as of the close of the plan year of the error are forfeited. Amounts forfeited are used according to the plan’s forfeiture provisions in place for the year of the error. If an excess amount has already been distributed to an HCE, the employer must notify the employee that the distribution was not eligible for favorable tax treatment,

Employer S maintains a 401(k) plan that uses the current year ADP testing method.

The plan provides for matching and after-tax contributions.

Matching contributions equal 50% of the sum of elective deferrals and after-tax contributions that do not exceed 10% of the employee’s compensation.

Matching contributions are subject to a 5-year graded vesting schedule.

Matching contributions are forfeited and used to reduce employer contributions if associated elective deferrals or after-tax contributions are distributed to correct an ADP, or ACP test failure.

For 2005, only NHCEs made after-tax contributions.

Two HCEs were eligible in 2005, Employee P and Employee Q.

Employee P made elective deferrals of $10,000, which was 10% of his compensation for 2005 ($100,000).

Employee Q made elective deferrals of $9,500, which was 8% of his 2005 compensation ($118,750).

Employee P received a matching contribution of $5,000 (50% of


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such as a tax-free rollover. If an excess matching amount that should have been forfeited has been paid to an HCE, this amount is an Overpayment that must be corrected (see Failure to satisfy the defined contribution annual additions limit, where the portion of the excess attributable to matching and nonelective contributions has already been distributed). The total QNEC amount to be allocated to NHCEs is the sum of all excess contributions adjusted for earnings through the date of the correction, excluding forfeited related matching contributions. Plan forfeitures may not be used to fund the QNEC. The plan sponsor must pick the group of employees who will receive the contribution from the following choices*:

Individuals who were eligible to participate and were NHCEs in the year of the error.

Individuals who were eligible to participate and were NHCEs both in the year of the error and the year of correction.

Individuals who were eligible to participate and were NHCEs in the year of the error, but who are still employees as of a date in the year of correction that is no later than the date of correction.

Individuals who were eligible to participate and were NHCEs both in the year of the error and the year of correction, but who are still employees as of a date in the year of correction that is no later than the date of correction.

*The four options listed above assume the plan sponsor uses the current year testing method. If the prior year testing method is used, substitute “the year prior to the year of the error” for “the year of the error” in the dot

$10,000).

Employee Q received a matching contribution of $4,750 (50% of $9,500).

Employees P and Q were 100% vested in 2005.

In 2007, it was discovered that testing for 2005 was performed incorrectly.

When rerun, the 2005 ADP test was not satisfied.

The 2005 HCE ADP was 9%.


The plan would not have passed the ADP test if the prior year method was used.

The ACP test would have been satisfied for 2005 without any corrective action.

Employer S calculates the dollar amount of the excess contributions for the two HCEs.

The excess contribution for Employee P is $3,437.50.

The earnings on Employee P’s excess are $687.

Employee P receives a distribution of $4,124.50 ($3,437.50 plus $687).

The excess contribution for Employee Q is $2,937.50.

The earnings of Employee Q’s excess are $587.

Employee Q receives a distribution of $3,524.50 ($2,937.50 plus $587).

The total of the excesses, adjusted for earnings, is $7,649.

Employer S makes a corrective contribution to the plan in the amount of $7,649.

The corrective contribution is allocated to eligible NHCEs for 2005, pro rata based on 2005 compensation.

Employee P’s and Employee Q’s matching contributions related to the distributed excesses, adjusted for earnings, are forfeited.

The forfeited amounts are used to reduce contributions for 2007 and subsequent years.


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points above. Regardless which group the employer selects to receive the contribution, it is allocated to each employee as a uniform allocation (as a percentage of compensation). The allocation is not adjusted further for earnings. It is treated as an annual addition for the year of the error. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees to reduce the number of employees eligible to receive QNECs. Likewise, restructuring the plan into component plans is not permitted to reduce the number of employees eligible to receive QNECs.

4. Failure to distribute elective deferrals in excess of the section 402(g) limit.

The plan must distribute the excess deferral, and allocable earnings, to the employee and report the amount as taxable in the year of deferral and the year distributed. The inclusion of the deferral and the distribution in gross income applies whether or not any portion of the excess deferral is a designated Roth contribution.

A distribution to a highly compensated employee is included in the ADP test.

A distribution to a nonhighly compensated employee is not included in the ADP test.

Employer P maintains a 401(k) plan.

Employee W (an HCE) and Employee U (a NHCE) each exceeded the section 402(g) deferral limit of $15,500 in 2007.

The error is discovered in May of 2008.

The 2007 Form W-2 for Employee W and Employee U will reflect deferrals greater than $15,500. The employees will be allowed to defer taxation on only $15,500 when they file their tax return. The employees will need to report the excess as taxable income in 2007.

The amounts deferred above $15,500, adjusted for earnings, are removed from the accounts and distributed to Employee W and Employee U in 2008.

Employee W and Employee U will receive a 2008 Form 1099R showing the excess amounts removed, and allocable earnings, as taxable in 2008.

The excess amount distributed to Employee W is included in the 2007 ADP test.

The excess amount distributed to Employee U is not included in the 2007 ADP test.


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5. Employee elective deferral failure that does not exceed 3 months.

No employer contribution is required to correct missed elective deferrals if all of the following conditions are satisfied:

The correct deferrals begin by the earlier of: o The first payroll period occurring 3 months

following the initial date of the error, or o The first payroll period occurring on or after the

last day of the month following the month in which the participant notified the plan sponsor of the failure.

The employer makes corrective contributions to make up for missed matching contributions, adjusted for earnings; and

Affected employees are notified within 45 days following the date the correct deferrals begin. Participant notices must contain all of the following information: 1. General information relating to the failure, such as

the deferral percentage that should have applied and the approximate date that the deferrals should have begun;

2. A statement that appropriate amounts have begun to be deducted from compensation and contributed to the plan (or will begin shortly);

3. A statement that corrective contributions for missed matching contributions have been made (or will be made);

4. An explanation that the participant may increase his deferral percentage to make up for the missed deferral opportunity, subject to applicable limit under section 402(g); and

5. The plan name and plan contact information (including name, street address, e-mail address, and telephone number of a plan contact).

6. Employee elective deferral failure that extends beyond 3

The plan sponsor must make a QNEC to the plan for the employee that is equal to the “missed deferral opportunity.” The missed deferral opportunity is equal to


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months but not past the SCP Significant Failure Deadline.

25% of the “missed deferral.” Under a non-safe harbor 401(k) plan, the missed deferral is equal to the ADP for the employee’s group (either HCE or NHCE) multiplied by compensation for the time period the exclusion occurred. Compensation can be prorated for this purpose. In a safe harbor 401(k) plan, the employee’s missed deferral is determined by multiplying 3% (or, if greater, whatever percentage of the participant’s compensation which, if contributed as an elective deferrals, would have been matched at a rate of 100% or more) by the employee’s plan compensation for the time period the exclusion occurred. In addition, all of the following conditions must be satisfied:

The correct deferrals begin by the earlier of: o The first payroll period occurring after the last day

of the second plan year following the plan year in which the error occurred, or

o The first payroll period occurring on or after the last day of the month following the month in which the participant notified the plan sponsor of the failure.

The employer also makes corrective contributions to make up for missed matching contributions, adjusted for earnings; and


the deferral percentage that should have applied and the approximate date that the deferrals should have begun;

2. A statement that appropriate amounts have begun


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to be deducted from compensation and contributed to the plan (or will begin shortly);

3. A statement that corrective contributions have been made (or will be made);



7. Employee elective deferral failure to implement an automatic contribution feature (available for failures beginning on or before December 31, 2020)

This correction method applies to both situations where the default contribution percentage was not applied and situations where an alternative percentage affirmatively elected by a participant in an automatic contribution plan was not applied. No employer contribution is required to correct missed elective deferrals if all of the following conditions are satisfied:

The correct deferrals begin by the earlier of: o The first payroll period occurring after 9½ months

following the end of the plan year in which the failure occurred, or

o The first payroll period occurring on or after the last day of the month following the month in which the participant notified the plan sponsor of the failure;

The employer makes corrective contributions to make up for missed matching contributions, adjusted for earnings; and


the deferral percentage that should have applied


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and the approximate date that the deferrals should have begun;

2. A statement that appropriate amounts have begun to be deducted from compensation and contributed to the plan (or will begin shortly);

3. A statement that corrective contributions for missed matching contributions have been made (or will be made);



8. Exclusion of an eligible employee from making employee post-tax contributions (to a defined contribution or defined benefit plan) or elective deferrals, or from receiving matching contributions for one or more plan years.

Defined contribution plan: The plan sponsor must make a contribution to the plan on behalf of the excluded employees. The corrective contributions must include lost earnings. If the employee was eligible to make an elective deferral contribution under a non-safe harbor 401(k) plan, the plan sponsor must make a QNEC to the plan for the employee that is equal to the “missed deferral opportunity.” The missed deferral opportunity is equal to 50% of the “missed deferral.” The missed deferral is equal to the ADP for the employee’s group (either HCE or NHCE). The employee’s missed deferral amount is reduced further to the extent necessary to ensure that the missed deferral does not exceed applicable plan limits, including the annual deferral limit. If the employee would have received an allocation of employer matching contributions under a non-safe harbor 401(k) plan, but did not receive the matching contributions because the employee was not given the opportunity to make elective deferrals, the employer must make a

Employer B maintains a 401(k) plan.

Employees may enter the plan on the January 1 or July 1 following the completion of one year of service.

Employee V (a NHCE), who met the eligibility requirements and should have entered the plan on January 1, 2006 was not offered the opportunity to participate for the 2006 plan year.

Employee V’s compensation for the 2006 plan year was $30,000.

For 2006, the ADP for NHCEs was 8% and the ACP for NHCEs was 2.63%.The ACP attributable to matching contributions for NHCEs was 2%. The ACP attributable to post-tax contributions was .63%

The error was discovered in 2007.

Employer B makes a QNEC for the excluded employee.

Elective Deferrals: Employee V receives a QNEC equal to the missed deferral opportunity for Employee V - 50% of Employee V’s missed deferral. The missed deferral for Employee V is $2,400 (8% x $30,000). The missed deferral opportunity is $1,200 (50% x $2,400). Thus, Employee V will receive $1,200 (plus earnings).

Matching contributions: Employee V should have been eligible for, but did not receive a matching contribution because Employee V was not provided the opportunity to make elective deferrals in 2006.


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corrected employer matching contribution on behalf of the affected employee. The corrective employer matching contribution will be equal to the matching contribution the employee would have received had the employee made a deferral equal to the missed deferral determined above, adjusted for earnings. If the employee was eligible to make employee post-tax contributions (other than designated Roth contributions), the employer must make a QNEC to the plan for the employee that is equal to 40% of the employee’s “missed post-tax contributions.” The employee’s missed post-tax contributions are equal to the ACP for the employee’s group (either HCE or NHCE). If the employee would have received an allocation of employer matching contributions under a traditional 401(k) plan, but did not receive the matching contributions because the employee was not given the opportunity to make post-tax contributions, the employer must make a corrective employer matching contribution on behalf of the affected employee. The corrective employer matching contribution will be equal to the matching contribution the employee would have received had the employee made post-tax contributions equal to the “missed post-tax contributions” determined above, adjusted for earnings. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees to reduce the number of employees eligible to receive QNECs. Likewise, restructuring the plan into component plans is not permitted to reduce the number of employees eligible to receive QNECs. These correction methods do not apply until other

Thus, Employer B must make a corrective employer matching contribution to the plan on behalf of Employee V that is equal to the matching contribution Employee V would have received had the missed deferral been made. Under the terms of the plan, if Employee V had made an elective deferral of $2,400 (8% x $30,000), the employee would have been entitled to a matching contribution of 100% of the first 3% of Employee V’s compensation ($30,000) or $900, plus earnings.

Post-tax contributions: Employee V was eligible to, but not provided with, the opportunity to make post-tax contributions from January 1 through August 31 of 2006. Employer B must make a QNEC for Employee V equal to the missed opportunity for making post-tax contributions for Employee V – 40% of Employee V’s missed post-tax contributions, adjusted for earnings. The missed post-tax contribution is $189 (.63% x $30,000). The missed opportunity to make post-tax contributions is $76 (40% x $189), adjusted for earnings.

The total required corrective contribution, before adjustment for earnings, for Employee V is $2,176 ($1,200+$900+$76). The corrective contribution for the missed deferral opportunity ($1200), the missed opportunity for post-tax contributions ($76), and earnings, must be made in the form of a QNEC.


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qualification failures are corrected. For example, if in addition to the failure of excluding an eligible employee, the plan also failed the ADP or ACP test, the correction methods described above cannot be used until after the correction of the ADP or ACP test failures. Defined benefit plan: The excluded employees must accrue their lost benefits.

9. Exclusion of an eligible employee from making employee post-tax contributions (to a defined contribution or defined benefit plan) or elective deferrals, or from receiving matching contributions for less than one year.

Exclusion for more than 3 months but less than one year The plan sponsor must make a contribution to the plan on behalf of the excluded employees. The corrective contributions must include lost earnings. If the employee was eligible to make an elective deferral contribution under a non-safe harbor 401(k) plan, the plan sponsor must make a QNEC to the plan for the employee that is equal to the “missed deferral opportunity.” The missed deferral opportunity is equal to 50% of the “missed deferral.” The missed deferral is equal to the ADP for the employee’s group (either HCE or NHCE) multiplied by compensation for the time period the exclusion occurred. Compensation can be prorated for this purpose. The employee’s missed deferral amount is reduced further to the extent necessary to ensure that the missed deferral does not exceed applicable plan limits, including the annual deferral limit. If the employee would have received an allocation of employer matching contributions under a traditional 401(k) plan, but did not receive the matching contributions because the employee was not given the opportunity to make elective deferral contributions, the employer must make a corrective employer matching contribution on behalf of the affected employee. The corrective employer matching contribution will be equal to the matching contribution the employee would have received had the

Example for exclusion for more than 3 months but less than one year:

Employer C maintains a non-safe harbor 401(k) plan.

Employees may enter the plan on the January 1 or July 1 after completing one year of service.

The plan provides for matching contributions equal to 100% of an employee’s elective deferrals up to 2% of compensation during the payroll period.

The plan provides for post-tax contributions, which may not exceed $1,000 for the plan year.

Employee X (a NHCE), who met the eligibility requirements and should have entered the plan on January 1, 2006 was not offered the opportunity to participate.

Employee X’s plan compensation for 2006 was $36,000.

The error was discovered in August 2006 and the employee was allowed to participate as of September 1, 2006.

Employee X made elective deferrals of 4% of compensation for each payroll period from September 1, 2006 to December 31, 2006.

The employee’s plan compensation for 2006 was $36,000 ($26,000 for the first eight months and $10,000 for the last four months).

Employer C made $200 in matching contributions to the excluded employee, which is 2% of the employee’s plan compensation for each payroll period from September 1, 2006 to December 31, 2006 ($10,000).


The 2006 NHCE ACP was 1.8%.

Employer C makes a corrective contribution for the excluded employee to make up the missed elective deferrals, matching contributions, and post-tax contributions.

Elective Deferrals: To calculate the QNEC for the missed elective


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employee made elective deferral contributions equal to the “missed deferral” determined above, adjusted for earnings. If the employee was eligible to make employee post-tax contributions (other than designated Roth contributions), the employer must make a QNEC to the plan for the employee that is equal to 40% of the employee’s “missed post-tax contributions.” The employee’s missed post-tax contributions are equal to the ACP for the employee’s group (either HCE or NHCE) multiplied by compensation for the time period the exclusion occurred. Compensation can be prorated for this purpose. If the employee would have received an allocation of employer matching contributions under a traditional 401(k) plan, but did not receive the matching contributions because the employee was not given the opportunity to make post-tax contributions, the employer must make a corrective employer matching contribution on behalf of the affected employee. The corrective employer matching contribution will be equal to the matching contribution the employee would have received had the employee made the post tax contributions equal to the “missed post-tax contributions” determined above, adjusted for earnings. The maximum corrective employer matching contribution that can be made to correct missed matching contributions and employee post-tax contributions is equal to the sum of the matching contributions that would have been made for the employee if the employee had contributed the maximum matchable contributions permitted and the maximum post-tax contributions permitted under the plan for the plan year, minus matching and/or post-tax contributions already made for/by the participant that plan year. Under this correction method, a plan may not be treated

deferrals, the employer pro-rates the employee’s plan compensation for the eight-month period that the employee was improperly excluded (8/12ths of $36,000, or $24,000). The missed deferral for Employee V is $720 (3% NHCE ADP times $24,000), adjusted for earnings. The missed deferral opportunity is $360 (50% x $720). Thus, Employee X will receive a QNEC equal to $360 (plus earnings) for the missed elective deferrals.

Matching contribution: Under the terms of the plan, if Employee X had made an elective deferral of $720 or 3% of compensation for the period of exclusion ($24,000), the employee would have been entitled to a matching contribution equal to 2% of $24,000 or $480. Employee X will receive a corrective employer matching contribution equal to $480 (plus earnings) for the matching contributions.

Post-tax contributions: Employee X was eligible to, but not provided with, the opportunity to make post-tax contributions from January 1 through August 31, of 2006. Employer C must make a QNEC for Employee X equal to the missed opportunity to make post-tax contributions (40% of Employee X’s missed post-tax contributions), adjusted for earnings. The missed post-tax contribution amount is $120 (8/12ths of the employee’s 2006 plan compensation of $36,000 ($24,000) x 0.5% ACP. The required corrective contribution is $48 (40% x $120), adjusted for earnings.

The total required corrective contribution for Employee X is $888 ($360 + $480 + $48), adjusted for earnings. The corrective contribution for the missed deferral opportunity ($360), the missed opportunity for the post-tax contributions ($48), and earnings must be made in the form of a QNEC.

Example for exclusion for 3 months or less in a plan year:

Employer E’s 401(k) plan allows employees to enter the plan on the January 1 or July 1 after completing one year of service.

The plan provides for matching contributions of 100% of elective deferrals, up to 2% of compensation per payroll period.

An NHCE should have entered the plan on January 1, 2006, but was not offered plan participation.

The error was discovered in March 2006 and the employee was allowed to participate as of April 1, 2006.

The amount the employee was allowed to defer was not less than the


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as two separate plans, one covering otherwise excludable employees and the other covering all other employees to reduce the number of employees eligible to receive QNECs. Likewise, restructuring the plan into component plans is not permitted to reduce the number of employees eligible to receive QNECs. These correction methods do not apply until other qualification failures are corrected. For example, if in addition to the failure of excluding an eligible employee, the plan also failed the ADP or ACP test, the correction methods described above cannot be used until after the correction of the ADP or ACP test failures.

Exclusion for 3 months or less in a plan year If the employee is allowed to make deferrals for at least the last 9 months of the plan year in an amount at least equal to the maximum permitted if no error occurred, then the employer is not required to make a corrective contribution with respect to elective deferrals or employee post-tax contributions. However, the employer is still required to make a corrective contribution to correct missed matching contributions. The corrective contributions must include lost earnings. The employer must make a corrective contribution to the plan for the employee that is equal to the ACP for the employee’s group (either highly compensated or nonhighly compensated) multiplied by compensation for the time period the exclusion occurred. Compensation can be prorated for this purpose. The maximum corrective contribution that can be made to correct missed matching contributions and employee post-tax contributions is equal to the sum of the matching

maximum deferrals the employee could have made if given the opportunity to defer on January 1, 2006.

The employee made elective deferrals of 4% of compensation for each payroll period from April 1, 2006 to December 31, 2006.

The employee’s plan compensation for 2006 was $40,000 ($8,000 for the first three months and $32,000 for the last nine months).

Employer E made $640 in matching contributions to the excluded employee, which is 2% of the employee’s plan compensation for each payroll period from April 1, 2006 to December 31, 2006 ($32,000).


The 2006 NHCE ACP was 1.8%.

Since the employee was given the opportunity to defer for at least the last 9 months of the plan year, Employer E is not required to make a corrective contribution to make up missed deferrals.

Employer E does need to make a corrective contribution to make up missed matching contributions.

The corrective contribution must include lost earnings.

To calculate the corrective contribution, the employer pro-rates the employee’s plan compensation for the three-month period that the employee was improperly excluded (3/12ths of $40,000, or $10,000).

The amount of the corrective employer matching contribution calculated to make up missed matching contributions is $200 (2% times $10,000), adjusted for earnings. However, when $200 is added to the matching contribution already received ($640), the total ($840) exceeds the $750 plan limit on matching contributions by $90. Therefore, the missed matching contribution is reduced to $110 ($200 minus $90). The required corrective employer matching contribution is $110, adjusted for earnings.


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contributions that would have been made for the employee if the employee had contributed the maximum matchable contributions permitted and the maximum post-tax contributions permitted under the plan for the plan year, minus matching and/or post-tax contributions already made for/by the participant that plan year.

10. Exclusion of an employee eligible to participate in a safe harbor 401(k) plan from making elective deferrals (other than designated Roth contributions).

In a safe harbor 401(k) plan, the employee’s missed deferral is determined by multiplying 3% (or, if greater, whatever percentage of the participant’s compensation which, if contributed as an elective deferrals, would have been matched at a rate of 100% or more) by the employee’s plan compensation for the portion of the year during which the employee was improperly excluded. For a traditional safe harbor plan, the employer must make a QNEC to the plan for the employee that is equal to the amount of the missed deferral opportunity (50% of the missed deferral) plus the applicable safe harbor matching or nonelective contribution. For a qualified automatic contribution arrangement (QACA) plan, the employer must make a corrective employer contribution for the applicable safe harbor matching or contribution, instead of a QNEC. The employee’s missed deferral amount is reduced further to the extent necessary to ensure that the missed deferral does not exceed applicable plan limits, including the annual deferral limit.

Example for traditional safe harbor 401(k) plan using safe harbor match of 100% up to 3% of compensation, plus 50% from 3% to 5% of compensation.

Employer G maintains a traditional safe harbor 401(k) plan that uses a rate of matching contributions to satisfy the safe harbor requirements.

Employee M, an NHCE, should have entered the plan on January 1, 2006, was not offered the opportunity to participate for the 2006 plan year.

The employee’s compensation for 2006 was $20,000.

Employer G makes a QNEC for the excluded employee.

Elective Deferrals: The employee’s missed deferral is 3% of compensation, or $600 (3% x $20,000). The required QNEC for the employee’s missed deferral opportunity in 2006 is $300 (50% x $600.)

Matching Contribution: The required QNEC for the missed matching contribution is $600.

The total required QNEC for the employee is $900 ($300 + $600), plus earnings.

Example for traditional safe harbor 401(k) plan using safe harbor match of 100% of elective deferrals up to 4% of compensation.

Same facts as above, except the plan provides for matching contributions equal to 100% of elective deferrals that do not exceed 4% of an employee’s compensation.


Elective Deferrals: The employee’s missed deferral is 4% of compensation, or $800 (4% x $20,000). The required QNEC for the employee’s missed deferral opportunity in 2006 is $400 (50% x


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$800).


The total required QNEC for the employee is $1,200 ($400 + $800), plus earnings.

Example for traditional safe harbor 401(k) Plan using nonelective contribution of 3% of compensation.

Same facts as above, except the plan uses a nonelective contribution equal to 3% of compensation to satisfy the safe harbor requirements.


Elective Deferrals: The employee’s missed deferral is 3% of compensation, or $600 ($20,000 x 3%). The required QNEC for the employee’s missed deferral opportunity in 2006 is $300 (50% x $600).


The total required QNEC for the employee is $900 ($300 + $600), plus earnings.

11. Failure to implement an employee contribution election for employee deferrals or post-tax contributions

For employees who made an election to make elective deferral contributions to the plan, which the employer failed to implement on a timely basis, the employer must make a QNEC to the plan for the employee that is equal to the “missed deferral opportunity.” The missed deferral opportunity is equal to 50% of the “missed deferral.” The missed deferral is equal to the employee’s elected deferral percentage multiplied by the employee’s compensation. If the employee elected a dollar amount for an elective deferral, the missed deferral would be the specified dollar amount. The employee’s missed deferral amount is reduced further to the extent necessary to ensure that the missed deferral does not exceed applicable plan limits, including the annual deferral limit. For employees who made an election to make post-tax

Employer K maintains a 401(k) plan.

The plan provides for matching contributions equal to 100% of elective deferrals that do not exceed 3% of an employee’s compensation.

On January 1, 2006, Employee T made an election to contribute 10% of compensation for the 2006 plan year. However, Employee T’s election was not processed and the required amounts were not withheld from Employee T’s salary in 2006.

For 2006, Employee T’s salary was $30,000.

Elective Deferrals: For the missed elective deferral, Employer K must make a QNEC to the plan on behalf of Employee T equal to 50% of Employee T’s missed deferral. The missed deferral is equal to $3,000 (10% x $30,000). Employer K makes a QNEC to the plan equal to $1,500 (50% x $3,000), adjusted for earnings.

Match: Employer K must make a corrective employer matching contribution to the plan on behalf of Employee T equal to the matching contribution Employee T would have received had the


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employee contributions under the plan, which the employer failed to implement on a timely basis, the employer must make a QNEC to the plan for the employee that is equal to 40% of the employee’s elected post-tax contribution percentage multiplied by the employee’s compensation. If the employee would have been entitled to a matching contribution on the missed deferral or post-tax contribution, the employer must make a corrective contribution equal to the matching contribution the employee would have received if the employee had made a deferral equal to the missed deferral (not reduced by 50%) or the missed post-contribution (not reduced by 60%). If the plan is a traditional safe harbor plan, the corrective contribution must be made in the form of a QNEC. All corrective contributions must be adjusted for earnings.

missed deferral been made. The corrective employer matching contribution is adjusted for earnings. Under the terms of the plan, if Employee T had made an elective deferral of $3,000, he would have been entitled to a matching contribution of 100% of the first 3% of compensation or $900 ($30,000 x 3%), plus earnings.

The total required corrective contribution for Employee T is $2,400 ($1,500 for the missed deferral opportunity plus $900 for the missed matching contribution), plus earnings. The corrective contribution for the missed deferral opportunity ($1,500) and related earnings must be in the form of a QNEC.

12. Exclusion of an eligible employee from a 401(k) plan that permits designated Roth contributions

Use the correction method for the exclusion of an employee from making pre-tax elective deferral contributions. The QNEC required to replace the missed deferral is made according to the method discussed for a traditional 401(k) plan or a safe harbor 401(k) plan, as applicable. However, the QNECs are not treated as designated Roth contributions and are not contributed to a designated Roth account. Instead, the contributions must be allocated as a QNEC or other employer contribution that is 100% vested and subject to withdrawal restrictions that apply to elective deferrals.

13. Exclusion of an eligible employee to make catch-up contributions to a 401(k) plan.

The employer makes a QNEC equal to 50% of the employee’s missed deferral attributable to catch-up contributions. The missed deferral is half of the catch-up limit for the year the employee was excluded.

Employer H maintains a 401(k) plan.

The plan limits deferrals to the lesser of the deferral limit or the annual additions limit. The plan also permits catch-up contributions.

The plan provides for a 60% matching contribution on elective deferrals. For 2006, the deferral limit is $15,000, and the catch-up


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If the employee was entitled to a matching contribution, the employer must make a corrective employer matching contribution equal to the additional matching contribution the employee would have received under the terms of the plan if the employee made a deferral equal to the missed deferral (50% of the catch-up limit for the year).

contribution limit is $5,000.

Employee R, age 55 is a nonhighly compensated employee who earned $60,000 in 2006 and made elective deferrals totaling $15,000 in 2006.

For 2006, Employee R was not provided the option to make catch-up contributions.

The missed deferral for Employee X is $2,500 (50% of $5,000) and the resulting QNEC is $1,250 (50% of $2,500).

In addition, Employee R was entitled to a matching contribution equal to 60% of the missed deferral attributable to the catch-up contribution that the employee would have made if the failure had not occurred. The missed deferral is $2,500 and the corresponding matching contribution is $1,500 (60% of $2,500).

Employer H makes a QNEC to the plan on behalf of Employee R equal to $1,250 for the missed deferral, adjusted for earnings.

In addition, Employee R makes a required corrective contribution for the additional matching contribution equal to $1,500, adjusted for earnings.

14. Exclusion of an eligible employee from receiving a profit sharing contribution. [Option 1]

The employer must make a corrective contribution for the amount the participant would have received under the plan’s allocation formula for that year. The corrective contribution must include lost earnings. If the exclusion of one employee caused another employee to receive more than he would have if the original contribution were properly allocated, the second employee’s account does not have to be reduced.

Employer D maintains a profit sharing plan that provides for a nonelective contribution which is allocated in the ratio that each eligible employee’s compensation bears to the compensation of all eligible employees for the plan year.

Employer D made a contribution for the 2006 plan year.

Five eligible employees were excluded from the allocation.

Employees who did receive the contribution received 10% of compensation.

Most of the employees who received the contribution were NHCEs.

If the five excluded employees had been included, all eligible employees would have received an allocation of 9% of compensation.

Employer D makes a corrective contribution to the five excluded employees equal to 10% of each employee’s compensation, adjusted for earnings.

15. Exclusion of an eligible employee from receiving a profit

The employer must make a corrective contribution for the amount the participant would have received under the plan’s allocation formula for that year. The corrective

Employer D maintains a profit sharing plan that provides for a nonelective contribution, which is allocated in the ratio that each eligible employee’s compensation bears to the compensation of all


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sharing contribution [Option 2]

contribution must include lost earnings. In addition, the account balance of each employee who received more in the original allocation than he would have if the error had not occurred is reduced by that excess amount, adjusted for earnings. With respect to the adjustment for earnings, the following guidelines apply:

If most of the employees whose accounts are being reduced are NHCEs and there was an overall investment gain for the period from the date of the original contribution to the correction, the accounts do not have to be adjusted for earnings.

If most of the employees whose accounts are being reduced are NHCEs and the accounts are adjusted for earnings, the employer can use the lowest earnings rate for any fund from the period from the original contribution to the correction.

If an employee took a distribution before the date of the correction, that employee may keep that distribution if most of the employees who took distributions are NHCEs. If the total amount of contributions to be made for excluded employees is less than the total amount of decreases in accounts, the amount by which employees’ accounts are reduced is decreased on a pro-rata basis until the reductions equal the contribution amount and the employer does not have to make additional contributions.

eligible employees for the plan year.

Employer D made a contribution for the 2006 plan year.

Five eligible employees were excluded from the allocation.

Employees who did receive the contribution received 10% of compensation.

Most of the employees who received the contribution were NHCEs.

If the five excluded employees had been included, all eligible employees would have received an allocation of 9% of compensation.

The account balance of each excluded employee is increased by 9% of the employee’s 2006 compensation, adjusted for earnings.

The account balance of each of the eligible employees other than the excluded employees is decreased by 1% of the employee’s 2006 compensation, adjusted for earnings.

Employer D determines the earnings adjustment using the earnings rate of each eligible employee’s excess allocation, using reasonable, consistent assumptions.

The total of the reductions in account balances exceeds the total of required increases.

The initially determined reductions are decreased pro rata so that the total of the actual reductions in account balances equals the total of the increases in account balances, and Employer D does not make a corrective contribution.

16. Failure of a 403(b) plan to satisfy the universal availability rule.

If the employee was not provided the opportunity to elect and make elective deferrals to a 403(b) plan, in lieu of determining the missed deferral based on the ADP as described above, the missed deferral is equal to the greater of 3% of compensation of the maximum deferral percentage for which the plan sponsor provides a matching contribution rate that is at least as favorable as 100% of the elective deferral made by the employee.

Employer H maintains a 403(b) plan.

The plan provides for matching contributions equal to 100% of elective deferrals that do not exceed 3% of an employee’s compensation.

On January 1, 2012, Employee D was eligible to contribute to the plan, but was not given the opportunity to participate.

For 2012, Employee D’s salary was $30,000.

Elective Deferrals: For the missed elective deferral, Employer H must make a QNEC to the plan on behalf of Employee D equal to 50% of Employee D’s missed deferral. The missed deferral is equal


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to $900 (3% x $30,000). Employer H makes a QNEC to the plan equal to $450 (50% x $900), adjusted for earnings.

Match: Employer H must make a corrective employer contribution to the plan on behalf of Employee D equal to the matching contribution Employee D would have received had the missed deferral been made. The corrective employer contribution is adjusted for earnings. Under the terms of the plan, if Employee D had made an elective deferral of $900, he would have been entitled to a matching contribution of 100% of the first 3% of compensation or $900 ($30,000 x 3%), plus earnings.

The total required corrective contribution for Employee D is $1,350 ($450 for the missed deferral opportunity plus $900 for the missed matching contribution), plus earnings. The corrective contribution for the missed deferral opportunity ($450) and related earnings must be in the form of a QNEC.

17. Failure to timely pay the required minimum distribution (RMD) under section 401(a)(9).

Defined contribution plan. The plan must distribute the RMDs. The amount to be distributed for each year in which the failure occurred must be determined by dividing the adjusted account balance on the applicable valuation date by the applicable divisor. For this purpose, adjusted account balance means the actual account balance, determined in accordance with section 1.401(a)(9)-5 Q&A 3 of the regulations, reduced by the amount of the total missed RMDs for prior years. Defined benefit plan. The plan must distribute the RMDs, plus an interest payment based on the plan’s actuarial equivalence factors in effect on the date the distribution should have been made. If the correction is made at the time the plan is subject to a restriction on single-sum payments, the plan sponsor must make a contribution to the plan equal to the amount distributed (or 50% of the amount distributed, if applicable under the benefit restriction rules).

Defined contribution plan example:

Employer N maintains a 401(k) plan.

Employee C, who is a 5% owner, reached 70½ in 2005.

In 2007, it is discovered that no RMDs have been paid from C’s account.

The plan’s valuation date is 12/31 of the applicable year.

The 2005 RMD is calculated by dividing Employee N’s account balance on 12/31/04 by the applicable life expectancy.

The 2006 RMD is calculated by subtracting the 2005 RMD amount from Employee N’s account balance on 12/31/2005, then dividing by the applicable life expectancy.

18. Failure to obtain participant and/or spousal consent for a

The plan must notify the participant and the spouse, so that either:

The spouse can provide informed consent for the

In accordance with a plan’s automatic QJSA option, a married participant who retired would have received a QJSA of $600 per month payable for life with $300 per month payable to the spouse


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distribution subject to the participant and spousal consent rules.

distribution actually made, or

The participant may repay the distribution and receive a qualified joint and survivor annuity (QJSA).

If participant and/or spousal consent is required but cannot be obtained, the spouse must receive a QJSA based on the monthly amount that would have been provided under the plan at his or her retirement date. This annuity may be actuarially reduced to take into account distributions already received by the participant. However, the portion of the QJSA payable to the spouse upon the death of the participant may not be actuarially reduced to take into account prior distributions to the participant. As an alternative, the affected spouse may be given a choice between the options discussed above, or receiving a single-sum payment equal to the actuarial present value of the survivor annuity benefit (calculated using the applicable 417(e)(3) interest rate and mortality table.) If the correction is made at a time when the plan is subject to a restriction on single-sum payments, then the alternative correction is available only if the plan sponsor contributes to the plan the amount distributed (or 50% of the amount distributed, if applicable under the benefit restriction rules.)

upon the participant’s death.

Instead, the participant received a single-sum distribution equal to the actuarial present value of his accrued benefit under the plan.

The participant and his spouse did not consent to this distribution.

The employer gives the spouse a choice to either consent to the distribution, receive a QJSA, or receive a single-sum payment equal to the actuarial present value of the survivor annuity benefit.

Under the QJSA option, the $600 monthly annuity payable during the participant’s lifetime may be actuarially reduced to consider the single sum distribution. However, the spouse is entitled to receive an annuity of $300 per month payable for life beginning at the participant’s death.

If the spouse elects to receive the single-sum payment option, the actuarial present value of a $300 per month annuity payable to the spouse for the spouse’s life beginning upon the participant’s death is $7,837, so the single-sum payment is equal to $7,837.

19. Failure to satisfy the defined contribution annual additions limit (i.e., excess annual additions) for limitation years beginning before January 1, 2009.

For excess annual additions other than elective deferrals and employee post-tax contribution, the plan must place the excess annual additions into an unallocated suspense account, to be used as an employer contribution in the succeeding year(s). While these amounts remain in the unallocated account, the plan sponsor may not make additional contributions to the plan. For excess annual additions that are elective deferrals or employee post-tax contributions, the plan must distribute the elective deferrals or employee post-tax contributions, with allocable income.

Employer G maintains a 401(k) plan that provides for nonelective contributions, elective deferrals, and post-tax contributions.

Nonelective contributions are subject to a 3-year cliff vesting schedule.

When an employee terminates employment, the plan provides that the nonvested account balance is forfeited after 5 years, and forfeitures are used to reduce employer contributions.

In 2006, Employee T’s annual additions limit was $44,000.

Employee T received $29,300 in nonelective contributions, made elective deferral contributions of $15,000, and $500 in post-tax contributions.

Employee T’s total excess annual addition was $800.

Employer G distributes the $500 in post-tax contributions (adjusted


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Elective deferrals and employee post-tax contributions that are matched may be returned, if the matching contributions relating to such contributions are forfeited (which will also reduce excess annual additions for the affected individuals). The forfeited matching contributions must be placed into an unallocated account to be used as an employer contribution in succeeding periods.

for earnings) and $300 of elective deferrals (adjusted for earnings).

20. Failure to satisfy the defined contribution annual additions limit (i.e., excess annual additions) for limitation years beginning on or after January 1, 2009.

For excess annual additions that are consisting of employer contributions and elective deferrals or after-tax employee contributions, then the correction is made by first distributing the unmatched employee post-tax contributions (adjusted for earnings), and then the unmatched elective deferrals (adjusted for earnings). If any excess remains, and is attributable to either matched elective deferrals or post-tax contributions, then the plan must distribute the matched post-tax contributions (adjusted for earnings). The forfeited matching contributions must be placed into an unallocated account to be used as an employer contribution in succeeding periods. If any excess remains, the plan distributes the matched elective deferrals (adjusted for earnings). The forfeited matching contributions must be placed into an unallocated account to be used as an employer contribution in succeeding periods. Any remaining excess amounts attributable to matching contributions or nonelective employer contributions are forfeited to a suspense account to be used as an employer contribution in succeeding periods.



When an employee terminated employment, the plan provides that the nonvested account balance is forfeited after 5 years, and forfeitures are used to reduce employer contributions.

The plan provides for matching contributions that are equal to 100% of an employee’s elective deferrals that do not exceed 8% of compensation.

In 2009, Employee T’s compensation was $100,000 and Employee T’s annual additions limit was $49,000.

Employee T received $25,000 in nonelective contributions, $16,500 in elective deferral contributions, $8,000 in matching contributions, and $1, 000 in post-tax contributions,

Employee T’s total excess annual addition was $1,500.

Employer G first distributes $1,000 in post-tax contributions (adjusted for earnings) and $500 of elective deferrals (adjusted for earnings).

21. Failure to satisfy the defined contribution annual additions limit with respect to an NHCE …

Who had annual

The annual additions excess is deemed to consist solely of matching and nonelective contributions. If the excess (adjusted for earnings) has been forfeited, the error is deemed to be corrected. No further corrective action is necessary.



When an employee terminates employment, the plan provides that the nonvested account balance is forfeited after 5 years, and


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additions consisting of both a) Elective

deferrals, employee after-tax contributions, or both; and

b) Matching contributions, nonelective contributions, or both.

Whose matching and nonelective contributions equal or exceed the amount of the excess annual additions.

Who has terminated employment with 0% vesting in the matching and nonelective contributions (and is not reemployed at the time of the correction).

If the excess (adjusted for earnings) has not been forfeited, either:

The excess amount is placed in an unallocated account to be used to reduce employer contributions in succeeding years, or

If the amount would have been allocated to other employees for the year of the error if the error had not occurred, that amount is allocated to the other employees according to the plan’s allocation formula.

forfeitures are used to reduce employer contributions.

In 2005, Employee U’s annual additions exceeded the limit by $300.

On January 1, 2006, Employee U terminated employment with 3 years of service and received his entire vested account balance (which consisted of his elective deferrals).

Employee U’s nonvested account balance is reduced by $300 (adjusted for earnings)

The $300 is placed in an unallocated suspense account to be used to reduce employer contributions in succeeding year(s).

22. Failure to satisfy the defined contribution annual additions limit, where the portion of the excess attributable to matching and nonelective

Either of the following methods can be used: a)The employer takes reasonable steps to have the

overpayment returned to the plan by the participant. The amount to be returned is the excess amount, including earnings to the date of distribution, plus appropriate interest from the date of distribution to the date of the repayment.

Employer X maintains a 401(k) plan that provides for nonelective contributions, elective deferrals, and post-tax contributions.


In 2005, Employee M’s annual additions exceeded the limit by $300.

On January 1, 2006, Employee M terminated employment with 7 years of service and received his entire account balance (Employee M was 100% vested).


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contributions has already been distributed.

If the participant does not repay the full amount of the overpayment (adjusted for earnings at the plan’s earnings rate), or if the employer chooses not to attempt to recover the overpayment from the participant, then the employer or another person contributes the difference to the plan. Note: In certain overpayment situations, the employer is not required to contribute the difference to the plan (e.g., impermissible in-service distributions).

The overpayment, adjusted for earnings at the plan’s earnings rate to the date of repayment, is either

Placed in an unallocated account to be used to reduce employer contributions in succeeding years, or

if the amount would have been allocated to other employees for the year of the error if the error had not occurred, that amount is allocated to the other employees according to the plan’s allocation formula.

The employer must also notify the participant that the overpayment was not eligible for favorable tax treatment (e.g., the overpayment was not eligible for rollover).

b) Adopt a Retroactive Amendment. The plan sponsor may adopt a retroactive amendment to conform the plan document terms to the plan’s operation. The amendment must comply with all correction principles and applicable qualification requirements, including nondiscrimination requirements.

Employer X notifies Employee M that he was not eligible to receive a portion of the distribution and that $300 adjusted for earnings through the date of the plan distribution must be returned to the plan. This amount must also include appropriate interest from the date Employee M received the distribution to the date it is repaid to the plan.

Employer X also notifies Employee M that the overpayment (i.e., $300 adjusted for earnings) was not eligible for rollover.

Employee M repays the $300, adjusted for earnings. This amount is placed in an unallocated account to reduce employer contributions in succeeding years.

23. Overpayments because of amounts paid in excess of the defined benefit annual

Any of the following methods can be used: a) Return of Overpayment. The employer takes

reasonable steps to have the overpayment (with

Example of Adjustment of Future Payments Method

Employer F maintains a defined benefit plan funded solely through employer contributions.

The plan provides that the benefits of employees are limited to the


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benefit limit. appropriate interest) returned to the plan by the participant. Future benefit payments (if any) due to the recipient are reduced to reflect the annual benefit limit.

If the amount returned is less than the overpayment (adjusted for earnings at the plan’s earnings rate), or if the employer chooses not to attempt to recover the overpayment from the participant, then the employer or another person contributes the difference to the plan. The employer must also notify the recipient that the overpayment was not eligible for favorable tax treatment (e.g., the overpayment was not eligible for rollover).

b) Adjustment of Future Payments. If benefits are

being distributed in periodic payments, future payments to the recipient are reduced so that they do not exceed the maximum annual benefit limit. An additional reduction is made to recoup the overpayment (over a period not longer than the remaining payment period) so that the actuarial present value of the additional reduction is equal to the overpayment plus interest at the interest rate used by the plan to determine actuarial equivalence.

If the employee is receiving payments in the form of a joint and survivor annuity, with the employee’s spouse to receive a life annuity upon the employee’s death equal to a percentage of the amount being paid to the employee, the reduction of future annuity payments to reflect section 415(b) reduces the amount of benefits payable during the lives of both the employee and spouse, but any reduction to recoup overpayments made to the employee does not reduce the amount of the spouse’s survivor benefit. Thus, the spouse’s

maximum amount permitted under section 415(b), disregarding cost-of-living adjustments after benefit payments have started.

Employee S retired at the beginning of the 2006 plan year and started receiving an annual straight life annuity of $185,000 from the plan.

Due to an administrative error, the amount received by Employee S for 2006 included an overpayment of $10,000 (because the benefit limit for 2006 was $175,000).

The error was discovered at the beginning of 2007.

Future annuity payments to Employee S are reduced so that they do not exceed the maximum limit.

Employee S’s future benefit payments from the plan are also actuarially reduced to recoup the overpayment, beginning in 2007.

The actuarial reduction for Employee S is $1,000 annually for life since the actuarial present value of a benefit of $1,000 annually for life commencing in 2006 is equal to the sum of $10,000 and interest at the rate used by the plan to determine actuarial equivalence beginning with the date of the first overpayment and ending with the date the reduced annuity payment begins.

Employee S’s remaining benefit payments are reduced so the she receives $174,000 for 2007 and each year thereafter.

Example of Adjustment of Future Payments Method


The plan provides that the benefits of employees are limited to the maximum amount permitted, disregarding cost-of-living adjustments after benefit payments have started.

Employee S retired at the beginning of the 2006 plan year and started receiving an annual straight life annuity of $175,000 from the plan.

Due to an administrative error, the amount received by Employee S for 2006 included an overpayment of $10,000 (because the benefit limit for 2006 was $175,000).


Employer F recoups the entire excess payment made in 2006 from Employee S’s remaining benefit payments for 2007.


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benefit will be based on the previous specified percentage (e.g., 75%) of the maximum permitted under section 415(b), instead of the reduced annual periodic amount payable to the employee.

c) Adopt a Retroactive Amendment. The plan sponsor

may adopt a retroactive amendment to conform the plan document terms to the plan’s operation. The amendment must comply with all correction principles and applicable qualification requirements, including nondiscrimination requirements.

Employee S’s annual annuity benefit for 2007 is reduced to $164,400 to reflect the excess benefit amounts (increased by interest) that were paid from the plan to Employee S during the 2006 plan year.

Beginning in 2008, Employee S begins to receive annual benefit payments of $175,000.

Example of Return of Overpayment Method


The plan provides that the benefits of employees are limited to the maximum amount permitted, disregarding cost-of-living adjustments after benefit payments have started.

Employee S retired at the beginning of the 2006 plan year and received a single-sum distribution that exceeded the benefit limit by $110,000


Employer F notifies Employee S of the $110,000 overpayment and that the overpayment was not eligible for favorable tax treatment (e.g., payment was not eligible for rollover).

The notice also asks Employee S to return the overpayment (with interest at the rate used by the plan to calculate the single-sum payment) to the plan.

Employee S pays the $110,000 (plus the requested interest) to the plan.

The plan’s earnings rate for the relevant period was 2% more than the rate used by the plan to calculate the single-sum payment. Employer F contributes the difference to the plan.

24. Vesting error in a defined contribution plan that results in forfeiture of too large a portion of the employee’s account balance.

The following methods can be used. a) Contribution Correction Method

The employer makes a corrective contribution to the employee whose account balance was forfeited in error in an amount equal to the improper forfeiture. The corrective contribution includes lost earnings. If the improper forfeiture resulted in an additional allocation to the account balance of another employee, no reduction is made to the account balance of that employee.

Employer E maintains a profit sharing plan that allows a nonelective contribution.

The plan also provides the forfeitures are reallocated among the other eligible employees, based on compensation.

In 2006, Employee R terminated employment and received a single-sum distribution of his vested benefit.

No other distributions to Employee R have been made since 2006.

The amount of the 2006 distribution was based on an incorrect vesting percentage, causing that distribution to be less than the amount to which the employee was entitled.


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b) Reallocation Correction Method

The employer must make a corrective contribution to the account of the affected participant(s) for the amount of the improper forfeiture. The corrective contribution must include lost earnings. In addition, the account balance of each employee who received more of the forfeiture allocation than he would have if the error had not occurred is reduced by that excess amount, adjusted for earnings. With respect to the adjustment for earnings, the following guidelines apply:

If most of the employees whose accounts are being reduced are NHCEs and there was an overall investment gain for the period from the date of the original forfeiture allocation to the correction, the accounts are not required to be adjusted for earnings.

If most of the employees whose accounts are being reduced are NHCEs and the accounts are adjusted for earnings, the employer can use the lowest earnings rate for any fund from the period from the original forfeiture allocation to the correction.

If an employee took a distribution prior to the date of the correction, that employee may keep that distribution if most of the employees who took distributions are NHCEs.

If the total amount of contributions to be made for employees whose accounts were improperly forfeited is less than the total amount of decreases in accounts, the amount by which employee’s accounts are reduced is decreased on a pro-rata basis until the reductions equal the contribution amount.

The remaining portion of the employee’s account was forfeited and reallocated to other participants, most of whom were NHCEs.

Contribution Correction Method

Employer E contributes the incorrectly forfeited amount (adjusted for earnings) to Employee R’s account.

The balances of the employees who received a portion of the forfeiture allocation are not reduced.

Reallocation Correction Method

Employer E contributes the incorrectly forfeited amount (adjusted for earnings) to Employee R’s account.

The account of each employee who shared in the allocation of the improper forfeiture is reduced by the amount of the improper forfeiture allocated to his account, adjusted for earnings.

Since most of the employees whose account balances are being reduced are NHCEs, Employer E uses the earnings rate of the fund with the lowest earnings rate for the period of the error to adjust the reduction to each account.

It is determined that the amount (adjusted for earnings) of the contribution to be made to Employee R is greater than the total amount by which the other accounts are reduced.

Employer E makes a contribution to the plan equal the difference between the amount to be contributed to Employee R and the reductions to be made to the other accounts

The reductions are made on a pro-rata basis among all funds in which the employee’s account balance is invested.

25. All overpayment Overpayments from a defined benefit plan


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errors, including distributions exceeding the employee’s or beneficiary’s benefit under the plan due to an error in applying the compensation limit ($200,000 as indexed), an error in forfeiting nonvested ACP excesses, or an error in forfeiting matching contributions attributable to Excess Amounts.

Use correction methods allowed for “Overpayments because of amounts paid in excess of the defined benefit annual benefit limit” above. Overpayments from a defined contribution plan Use correction methods allowed for “Failure to satisfy the defined contribution annual additions limit, where the portion of the excess attributable to matching and nonelective contributions has already been distributed” above.

26. Allocation of contributions or forfeitures under a defined contribution plan based on compensation in excess of the compensation limit ($200,000 as indexed). [Option 1]

The account balance of the employee that received the erroneous allocation is reduced by the improper amount, adjusted for earnings. If the improper amount would have been allocated to other employees if the error had not occurred, that amount (adjusted for earnings) is reallocated to those employees according to the plan’s allocation formula. If the improperly allocated amount would not have been allocated to other participants, that amount (adjusted for earnings) is placed in an unallocated account, to be used to reduce employer contributions in succeeding year(s). If an employee received a distribution that included an improperly allocated amount, refer to the section titled “Overpayment errors” for corrective options.

Employer J maintains a money purchase plan.

Each eligible employee receives 8% of his compensation as an employer contribution under the plan.

In 2006, the compensation of one employee was not limited to $220,000 (the compensation limit in 2006), resulting in an allocation of $2,400 more than what he was eligible to receive.

To correct the error, the employee’s account balance is reduced by $2,400 (adjusted for earnings).

The $2,400 (adjusted for earnings) is placed in an unallocated suspense account to be used to reduce employer contributions in succeeding year(s).

27. Allocation of contributions or forfeitures under a defined contribution plan based on

The employer contributes an additional amount to each of the other employees (excluding each employee who received too large an allocation due to the error) who received an allocation for the year of the error, amending the plan (as necessary) to provide for the additional

Employer J maintains a money purchase plan.

Each eligible employee receives 8% of his compensation as an employer contribution under the plan.

In 2006, the compensation of one employee was not limited to $220,000 (the compensation limit in 2006), resulting in an allocation


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compensation in excess of the compensation limit ($200,000 as indexed). [Option 2]

allocation. The amount contributed to these employees is equal to the employee’s plan compensation multiplied by a fraction. The numerator of the fraction is the largest amount that was improperly allocated to any employee. The denominator of the fraction is the compensation limit in effect for the year the error occurred. The corrective allocation must include lost earnings.

of $2400 more than what he was eligible to receive.

Employer J amends the plan to increase the contribution percentage for all eligible employees (other than the employee who received the erroneous contribution) by 1.09% for the 2006 plan year ($2400/$220,000 =1.09%).

Employer J contributes an additional 1.09% (adjusted for earnings) for those employees for the 2006 plan year.

28. Hardship distributions made under a plan that does not allow hardship distributions or plan loans made under a plan that does not allow plan loans.

The plan is amended retroactively to allow hardship distributions or plan loans. The amendment must be submitted to the IRS for determination, using the correct application form (i.e., the Form 5300 series). If the error is significant and the employer is correcting under SCP, the submission must be made before the end of the plan’s remedial amendment period. If the employer is correcting the error under VCP, a copy of the amendment, the application form, and the appropriate user fee must be sent with the VCP submission. The amendment must satisfy the qualification requirements of section 401(a) as of the effective date of the amendment, and as of the date the amendment is adopted.

Employer K maintains a 401(k) plan that does not permit hardship distributions.

In 2005, hardship distributions were made available to all participants.

Hardships were distributed to several participants in 2005 and 2006.

The error was discovered in 2007.

Employer K adopts a plan amendment to provide for hardship distributions.

The effective date of the amendment is January 1, 2005.

By making hardships available to all employees, the amendment satisfies section 401(a) at the time the amendment is adopted (2007) and would have satisfied section 401(a) if the amendment had been adopted in 2005.


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29. Inclusion of employee who has not met the plan’s minimum age or service requirement or who was included too soon due to an incorrect plan entry date.

The plan is amended retroactively to allow the inclusion of the ineligible employee to reflect the plan’s actual operations. Most of the employees affected by the amendment must be NHCEs. Generally, the amendment must be submitted to the IRS for determination, using the correct application form (i.e., the Form 5300 series). If the error is significant and the employer is correcting under SCP, the submission must be made before the end of the plan’s remedial amendment period. If the employer is correcting the error under VCP, a copy of the amendment, the application form, and the appropriate user fee must be sent with the VCP submission. The amendment must satisfy the qualification requirements of section 401(a) as of the effective date of the amendment, and as of the date the amendment is adopted. The amendment may change the eligibility provisions with respect to only those ineligible employees that were wrongly included.

Employer L maintains a 401(k) plan.

Employees must have 6 months of service to enter the plan.

The plan provides for both elective deferrals and matching contributions.

In 2007, Employer L discovers that all four employees hired in 2006 were permitted to enter the plan immediately.

Three of the four affected employees are NHCEs.

The elective deferral contributions made by the four employees were matched.

The plan passed the ADP and ACP tests, taking into account the contributions made by the four employees.

Employer L corrects the error under SCP by adopting a plan amendment.

The amendment provides that employees may enter the plan immediately.

The amendment is effective for employees hired on or after January 1, 2006 that were wrongly included.

Employer L submits the amendment to the IRS for a determination letter.

The following correction methods are only available under the VCP.

30. Employer Eligibility Error.

In general, all contributions (including salary deferrals and after-tax contributions) cease beginning no later than the date the application under VCP is filed.

The assets of the plan remain in the trust, annuity contract, or custodial account and are not distributed until a distributable event (e.g., death, disability, termination of employment, etc.).

The plan will still be subject to all of the 401(a) (or 403(b) if

Employer Z, a tax-exempt organization, adopted a 401(k) plan in 1994.

Employer Z was not eligible to sponsor a 401(k) plan in 1994 due to its tax-exempt status.

Employer Z discovers the error in 2001 and files a submission to correct the error under VCP.

Because Employer Z is eligible to maintain a 401(k) plan in 2001, contributions are allowed to continue.

The 401(k) plan must still meet all section 401(a) qualification requirements, and any operational, demographic, or plan document


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correcting a 403(b) plan) requirements.

Contributions can continue if that continuation is not an Employer Eligibility Error (e.g., the employer is now eligible to sponsor a 401(k) plan).

errors must be corrected with the VCP submission.

31. Loan Amount Exceeding the Maximum Permissible Amount ($50,000/50% Limit).

The participant repays the excess amount to the plan. If scheduled repayments were made before the error is discovered and corrected, the repayments may be taken into consideration by applying them:

To reduce the portion of the loan that didn’t exceed the maximum permissible amount;

To reduce the interest on the loan excess, with the remainder of the repayments applied to reduce the portion of the loan that didn’t exceed the maximum loan amount; or

Pro rata against the loan excess and the maximum loan amount.

Once the corrective repayment is made, the loan may be reformed to amortize the remaining principal balance over the remaining period of the original loan. This correction is not available if the maximum loan repayment period, taking into account any permissible suspension periods, has already expired.

Employee Q borrows $55,000 from her account in her 401(k) plan in 2006. The maximum permissible loan amount is $50,000.

On January 1, 2007, the error is discovered.

Under VCP, the employee repays the excess amount of $5,000 to the plan.

Loan repayments Employee Q made before the error was discovered that are attributable to the $5,000 excess may be applied: i) towards the remaining loan balance to Employee Q repays

the entire $5,000 and interest; ii) towards the interest on the loan excess, with any remaining

payments applied towards the remaining loan balance so Employee Q only repays the $5,000; or

iii) pro rata against the loan excess and the remaining loan balance so Employee Q repays an amount equal to the outstanding balance remaining on the excess on the date the corrective repayment is made.

The remaining loan balance may be reamortized over the remaining period of the loan.

32. Loan Repayment Period Exceeds the Maximum Permissible Repayment Period (5 years for a general purpose loan).

The loan balance is reamortized over the remaining portion of the maximum repayment period. This correction is not available if the maximum permissible repayment period, taking into account any permissible suspension periods, had already expired.

Employee O borrows $10,000 from his account in his profit sharing plan, to be repaid over a seven-year period. This loan is not a principal residence loan.

Three years later, the repayment period error is discovered.

Under VCP, the remaining loan balance may be reamortized over the two years remaining on the five-year maximum repayment period.

33. Loans that Do Not Meet the Level Amortization Requirements.

The loan balance is reamortized over the remaining portion of the maximum permissible repayment period in a manner that meets the level amortization requirements.

This correction is not available if the maximum loan repayment period, taking into account any permissible suspension periods, has already expired.

Employee P borrows $6,000 from her 403(b) plan on January 1, 2006. The loan repayment schedule was not set up in a manner that provided for substantially level payments of principal and interest made at least quarterly.

The error is discovered on January 1, 2007.

The loan balance is reamortized over the remaining 4 years in a


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manner that the loan schedule provides for substantially level payments of principal and interest made at least quarterly.

34. Loan Default Errors.

Where a loan is in default due to payments not being made as scheduled, such as when an employer does not begin taking deductions from a participant’s paycheck as scheduled, or accidentally stops deducting them too soon, the error may be corrected under VCP, by:

The participant making a lump sum payment equal to the amount of missed payments, plus accrued interest, and continuing with scheduled loan repayments going forward;

Reamortizing the outstanding loan balance, including accrued interest, over the remaining payment schedule of the original loan; or

A combination of the two correction methods.

If the employer is partially at fault for not beginning or continuing repayment of the loan, the IRS may require the employer to pay the additional interest owed by the participant for failure to timely repay the loan.

This correction is not available if the maximum loan repayment period, taking into account any permissible suspension periods, has already expired.

Employee H borrows $7,000 from his 401(k) plan.

Employee H’s employer changes payroll vendors, and as a result Employee H’s loan repayments are not taken as scheduled from his paycheck.

This error is discovered after the cure period, according to the plan’s loan policy, has expired.

Under VCP, the error may be corrected by: i) Employee H making a lump sum payment equal to the amount

of missed payments, plus accrued interest, and continuing with scheduled loan repayments going forward;

ii) Reamortizing the outstanding loan balance, including accrued interest, over the remaining payment schedule of the original loan; or

iii) A combination of these two correction methods.

The Pension Analyst is published by Prudential Retirement, a Prudential Financial business, to provide clients with information on current legislation and regulatory developments affecting qualified retirement plans. This publication is distributed with the understanding that Prudential Retirement is not rendering legal advice. Plan sponsors should consult their attorneys about the application of any law to their retirement plans.

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