How Do We Self-Correct a Failure to Enroll a New Employee in Our Automatic 401(k) Plan Contributions?

Question: Our 401(k) plan satisfies the nondiscrimination safe harbor under the Internal Revenue Code by requiring an automatic deferral of 3.5% for each new employee who doesn’t affirmatively elect a different percentage (or zero), and by providing a 100% matching contribution of up to 3.5% of compensation.

We have procedures in place to automatically enroll new employees. But because of an administrative error, one new employee wasn’t enrolled for an entire calendar year. How do we self-correct this failure?

Answer: The IRS’s Employee Plans Compliance Resolution System (EPCRS) offers several pre-approved methods that can be used to correct failures to implement automatic deferrals. The standard method for correcting full-year elective deferral failures (including enrollment failures under an automatic contribution arrangement) involves making a qualified nonelective contribution for 50% of the missed deferrals plus a contribution for the full amount of any missed matching or nonelective contributions.

But lower-cost methods may be available if the correction is made within specified timeframes. One of these methods reduces the qualified nonelective contribution for the missed deferrals to 25% of the missed deferrals if the correction occurs within the three-year period for self-correcting significant failures or, if earlier, by the end of the month after the month the employee notifies the plan sponsor of the failure.

Another method requires no qualified nonelective contribution for the missed deferrals if correct deferrals commence no later than the first paycheck issued after the three-month period that began when the failure first occurred (earlier if the employee notified the plan sponsor of the failure).

Although your new employee was excluded for more than three months, you may still be able to avoid a qualified nonelective contribution for that employee’s missed deferral opportunity using a temporary correction method that’s available only for automatic contribution arrangements.

This method originally expired at the end of 2020, but it was retroactively reinstated in the 2021 version of EPCRS for errors beginning before 2024. Before undertaking the method, check with your benefits advisor to verify that it’s still available. If it is, here’s a summary of the requirements for using this lower-cost method.

Avoiding a Qualified Nonelective Contribution

To avoid making a qualified nonelective contribution for the missed deferrals, you must:

• Correct the failure by the first compensation payment made on or after the last day of the 9-1/2-month period following the end of the plan year of the failure or, if earlier, by the end of the month following the month in which the employee gives notice of the failure,
• Provide a notice to the employee not later than 45 days after correct deferrals begin (see “Content of 45-Day Notice” below), and
• Make corrective contributions (adjusted for earnings) for any missed matching contributions.

Content of 45-Day Notice

The notice must include:

• General information relating to the failure, including the percentage that should have been deferred and the approximate date that the deferrals should have begun,
• A statement that correct deferrals have begun (or will begin shortly),
• A statement that corrective contributions for missed matching contributions have been or will be made,
• An explanation that the employee may increase the employee’s deferral percentage to make up for the missed deferral opportunity (subject to an annual dollar limit), and
• The plan’s name and contact information (including street address, email address and telephone number).

Qualified Nonelective Contribution for Missed Matching Contributions

The correction method requires a qualified nonelective contribution for any missed matching contributions. (For your plan, the qualified nonelective contribution would be 3.5% of the employee’s compensation as defined for determining automatic deferrals.)

The qualified nonelective contribution must be 100% vested, and it must not be distributable before death, disability, severance from employment, age 59 1/2 or plan termination, except as a hardship distribution.

In addition, the qualified nonelective contribution must be adjusted for earnings to the date of the correction, which under a special rule may be based on the earnings of the plan’s default investment alternative if the employee didn’t affirmatively designate an investment.

 

What Should We Do If Our 401(k) Plan Must Make a Distribution to Someone We Can’t Locate?

Question: Each year, when our 401(k) plan makes required minimum distributions, we discover that the addresses on file for some distributees are no longer valid. We sometimes have similar problems locating beneficiaries when a participant dies. What procedures should we follow when our plan must make distributions to individuals we can’t locate?

Answer: The U.S. Department of Labor (DOL) and the IRS have both offered guidance about dealing with participants and beneficiaries who are unresponsive or can’t be located — in other words, “missing participants.” However, the guidance isn’t all directly on point or highly detailed. The DOL’s most detailed guidance relates to terminating plans, and the IRS guidance relates to audits and the correction of distribution errors.

The DOL has also provided a list of best practices that ongoing plans can employ to minimize and mitigate the problem of missing participants, but those practices are only examples of steps that plan fiduciaries should consider in light of the plan’s participant population, the size of the participant’s benefit and the cost.

Although this guidance doesn’t offer a complete compliance roadmap, collectively it suggests doing the following.

Initial Search Steps

When a participant or beneficiary is unresponsive or you reasonably believe your contact information is inaccurate, consider these steps:

• Use certified mail (or a private delivery service with similar tracking features if less expensive),
• Check employer records and all employer plans for up-to-date information,
• Attempt to identify and contact the individual’s designated beneficiaries under those plans for information, and
• Use free electronic search tools, such as internet search engines, public record databases and social media.
• Use free electronic search tools such as internet search engines, public record databases, and social media.

These steps are required, in no particular order, for terminating plans.

The DOL’s best practices guidance includes other suggestions, such as reaching out to a participant’s colleagues or union and registering the individual on public or private pension registries. The DOL suggests that privacy concerns can be alleviated if the retirement plan fiduciary asks the employer, other plan fiduciary or beneficiary to have the missing individual contact the retirement plan. Nevertheless, employer-sponsored group health plans shouldn’t use nor disclose individually identifiable information unless the use or disclosure complies with the privacy rules of the Health Insurance Privacy and Accountability Act (HIPAA).

Additional Search Steps for Larger Account Balances

If the initial search steps are unsuccessful, searches that charge a fee may be appropriate when the account balance is large enough to justify the expense. (The fee may be charged against the account if reasonable and if the allocation method is consistent with the plan’s terms and rules set forth under the Employee Retirement Income Security Act [ERISA].) Additional steps could include internet searches, commercial locator services, credit-reporting agencies, information brokers, investigation databases and similar services charging a fee.

If Search Efforts Fail

Some plan documents describe how to handle account balances when search efforts fail. Others may authorize administrative committees to adopt policies for these situations. Following written policies and procedures for handling missing participants, and documenting actions taken, should help ensure consistency. Some plan provisions or policies direct fiduciaries to allocate the funds in the account among the accounts of the remaining participants, subject to restoration if the individual should reappear.

Under IRS regulations, such an allocation isn’t an impermissible forfeiture so long as the plan is obligated to restore the missing individual’s account balance.

Ongoing Practices

To minimize future problems with missing participants, the DOL’s best practices guidance encourages plans to be proactive in maintaining accurate census information. Periodically prompt participants and beneficiaries to reconfirm their contact information, regularly audit census information and pay special attention to contact information in business transactions or when recordkeepers change. Changing the way communications are written (and addressed, if mailed) can make it more likely that participants recognize their importance.

Consider other listed practices to help avoid missing participant searches later.