Administrative glitches are practically inevitable at some point when operating a retirement plan, given the myriad ways things can get off track. Case in point: inadvertently failing to add a newly eligible employee to your roster of 401(k) plan participants. While excluding an eligible employee isn’t the worst mistake you could make, it’s important to identify the error sooner rather than later and take prompt remedial action.

Common Errors

According to the IRS, typical causes for such errors include:

  • An employer’s faulty assumption that the plan doesn’t need to cover some part-time employees, or
  • Considering employees ineligible to participate because they choose not to make elective deferrals.

What kind of remedial action is called for? You need to go beyond simply reclassifying the employee as a participant; the IRS has very specific instructions on what to do. But before you dive into that, it’s often helpful to verify that you’re clear on how your plan document defines eligibility.

ERISA Standards

Although ERISA sets some minimum standards for defining eligibility, sponsors are free to be more generous. Under ERISA, an employee is eligible if the employee has attained age 21 and has completed a year of service (defined as a consecutive 12-month period) in which the employee has logged at least 1,000 hours of work. This is referred to as the maximum statutory requirement for eligibility. When using these requirements, a plan must allow the employee to enter the plan no later than six months after meeting the requirements.

ERISA regulations elaborate on these minimum requirements. For example, they define the starting point for calculating service time, among other issues. Check with your benefits specialist or third-party administrator (TPA) to review the details.

So what do you need to do if you’ve failed to timely enroll a participant? If you fix the error in less than three months after the employee should have been added to the plan, you’re off the hook. If not, the regulations require you to make a corrective qualified nonelective contribution (QNEC) to that participant’s account.

Calculating a QNEC

The regulations create a basic two-step formula for determining the amount of the QNEC: First, take the actual deferral percentage (ADP) for the employee’s category — such as non-highly compensated employee (NHCE) or highly compensated — and multiply it by the employee’s compensation during the period that he or she was eligible to participate but was mistakenly deemed ineligible. Second, multiply that number by 50%. The regulations reduce the 50% multiplier to 25% if you meet specific requirements and provide the affected employee with a notice within 45 days of being given the opportunity to make deferrals describing the failure and the correction being taken.

For example, suppose employee Mark was in the NHCE group and that group’s ADP was 8%. Mark’s annual compensation was $60,000, and he was wrongly excluded from participation for nine months. The math would be: $45,000 (earnings during that nine-month period) × 8% × 50% = $1,800.

QNEC contributions are automatically fully vested in the employee’s 401(k) account.  Different deadlines apply to errors made in plans that use auto-enrollment, and some “safe harbor” remediation alternatives are available. Again, check with your benefits specialist or TPA for the details. Don’t forget that any missed employer contributions, such as matching or profit sharing contributions, must be made to the accounts of affected participants.

Notifying Parties of the Fix

The IRS considers inadvertently neglecting to enroll an employee in your plan when the eligibility period has begun an “operational error.” That means you must remedy it using the IRS’s “Self-Correction Program” without notifying the agency itself. If the operational error is “significant” (based on subjective criteria defined by the IRS), you may need to file with the IRS under its Voluntary Correction Program. In any event, you need to notify the affected employee/participant of what has happened. The required contents of the notice can be found in Rev. Proc. 2016-51.

Then you must actually make the fix by the end of the second plan year after the year the error occurred ― or have it “substantially corrected within a reasonable period of time.”

There’s no specific deadline to fix “insignificant” operational errors.

Prevention is Key

An ounce of prevention is worth a pound of cure. Following those procedures, along with reviewing this subject with your plan’s employee benefits specialist, should help you avoid QNEC obligations and possibly straining your relationships with impacted employees.

IRS Recommendations for Avoiding Enrollment Errors

The IRS urges plan sponsors to take the following steps to avoid making mistakes around employee eligibility for plan participation:

  • Check how your plan document defines “employee” and plan participation eligibility requirements.
  • Train (or retrain) any employees who determine eligibility to participate in your plan.
  • Review payroll records for the total number of employees, birth dates, hire dates, hours worked and other pertinent information.
  • Check W-2 forms and state unemployment tax returns and compare the employee data they contain with your payroll records for any discrepancies.

Most important, create protocols and have a corrective action plan that will be triggered when you identify errors.

Headshot of Jenise Gaskin.

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