I can still hear my mother saying it, “Haste makes waste, Marcel.” And it is true in many situations – acting too quickly can cause mistakes that waste time and money. But it isn’t always the case with qualified plan failures. In most cases, timely correction of a failure will cost you less money and less bureaucratic hassle because the longer you wait, the more complicated the IRS correction program you will need to use. In this situation, as in many others, complexity wastes money.
There are three paths for correcting plan failures under the IRS’s Employee Plans Compliance Resolution System (EPCRS): the Self-Correction Program, the Voluntary Correction Program, and the Audit Closing Agreement Program (respectively, SCP, VCP, and Audit CAP). The growing complexity among the programs is obvious:
- SCP requires no IRS involvement.
- VCP requires submitting an application to the IRS.
- Audit CAP involves an IRS audit.
Using a sample plan, that of the fictional Acme, Inc., this article illustrates how the cost of correction can grow as time passes.
Imagine that our fictional Acme has 90 employees and sponsors a 401(k) plan that has 55 participants. The company improperly excluded 18 nonhighly compensated employees from participating in the plan. This means that 20% of Acme’s employees were improperly excluded from making salary deferral contributions to the plan and so did not receive employer matching contributions on those deferrals.
A general EPCRS correction principle is that plan participants are to be put in the same position in which they would have been if the plan failure had not occurred. The EPCRS correction for our sample failure is to contribute the following to the plan on behalf of the affected employees:
- 50% of the average deferral percentage for nonhighly compensated employees;
- 100% of the matching contributions that the employees would have received;
Applicable earnings from the dates when the salary deferrals and matching contributions would have been made to their plan accounts until the amounts are actually contributed.
The longer you wait to correct the failure, the more it will cost in terms of payments to the IRS and in earnings that will have to be contributed on the missed contributions. For our example, we will assume that there is a total of $50,000 in missed deferrals and matching contributions that will need to be contributed to the plan.
Failure Caught And Corrected Within Two Years – Correction Under SCP
In order to correct a significant plan failure (such as this example involving 20% of the employees) in SCP, you must substantially complete the corrections by the end of the second plan year after the end of the plan year in which the failure occurred. So in our example, if the plan failure occurred in 2016, you would have to complete your corrections by the end of 2018. The correction costs are as follows.
|Employees 50% of deferral percentage plus applicable match plus earnings||$54,000 – $50,000 plus $4,000 in earnings|
|Extra third party administration fees to calculate the corrections||$1,000 to $1,500|
|Possible attorney fees to assess significance and document corrections||$2,500|
Failure Caught And Corrected After 2 Years – Correction Under VCP
If a significant failure such as our example is not corrected within 2 years, the only way to ensure that the plan’s tax qualified status is protected is to submit an application under the VCP. This will cost more time and money than if the failure had been corrected within 2 years in SCP, as shown below.
|Employees 50% of deferral percentage plus applicable match plus earnings||$56,000 – $50,000 plus $6,000 in earnings|
|Extra third party administration fees to calculate the corrections||$1,500 to $2,500|
|VCP filing fee||$2,500|
|Possible attorney fees to prepare VCP and application and process until receipt of compliance statement||$3,500 to $5,000|
Generally, we would advise you to listen to your mother. However, when it comes to correcting failures in your retirement plan, we advise plan sponsors to ignore that advice and to be prompt, even hasty, in completing those plan corrections.
Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660.