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Fixing Common Plan Mistakes - Correcting a Failure to Implement the Plan’s Automatic Enrollment Provisions

The Problem

Two common errors found in 401(k) plans are not giving an eligible employee the opportunity to make elective contributions and failing to execute an employee’s salary deferral election. In both cases, the employer can fix the problem by using one of the programs available through the Employee Plans Compliance Resolution System (EPCRS). The remedy for both requires the employer to make a corrective contribution of 50% of the missed deferral (adjusted for earnings) for the affected employee. The employee is fully vested in these contributions and the contributions are subject to the same restrictions on withdrawal that apply to elective deferrals. The only difference in the correction for the two situations lies in the calculation of the amount of the missed deferral. In the case of an erroneously excluded employee, the missed deferral is based on the average of the deferral percentages (“ADP”) for other employees in the employee’s category (for example, nonhighly compensated employee). In the case of failure to implement an employee’s election, the missed deferral is based on the employee’s elected deferral percentage.

Many 401(k) plans provide an automatic enrollment feature. Under automatic enrollment, unless there is a specific election to the contrary, the employee is treated as having elected to make a contribution equal to the plan’s automatic enrollment deferral percentage. The employee also has the option of choosing to contribute an amount other than the plan’s automatic enrollment deferral percentage. The following question often comes up for automatic enrollment plans: How do we correct the mistake of not implementing automatic enrollment for employees? The answer to the question is based on the reason for the failure. Specifically, did the failure to implement automatic enrollment arise from the erroneous exclusion of an eligible employee? Or, did the failure arise because of the failure to execute the employee’s “election” (or more accurately, “non-election”)?

Let’s consider the following two examples. In both examples, the employees are nonhighly compensated employees (NHCEs) of the Engine Company (“Engine”). Engine sponsors a 401(k) plan (“Plan”), which provides that unless the employee elects otherwise, Engine will enroll the employee in the Plan and withhold 3% of compensation from the employee’s paycheck. For 2008, the ADP for NHCEs was 4%.

Example 1: Albert became eligible to participate in Engine’s Plan on January 1, 2008. Due to an oversight, Engine did not give Albert the plan’s enrollment materials. Included in the enrollment materials are: (i) a description of the plan, and (ii) the procedures for an eligible employee to elect to contribute an amount other than the automatic enrollment deferral percentage (including zero). Albert did not make any specific election and the Plan did not implement its automatic enrollment provision for Albert. As a result, Albert did not make any elective contribution to Engine’s Plan in 2008. Albert earned $30,000 in compensation in 2008.

Example 2: Bobbi became eligible to participate in Engine’s Plan on January 1, 2008. In November of 2007, the Plan sponsor gave Bobbi the Plan’s enrollment materials. Bobbi did not make any specific election and the Plan did not implement its automatic enrollment provision for Bobbi. As a result, Bobbi did not make any elective contribution to Engine’s Plan in 2008. Bobbi earned $30,000 in compensation in 2008.

Fixing the Mistake

Example 1: In failing to provide Albert with the Plan’s enrollment materials, the Plan effectively precluded him from making a timely election to contribute to the plan. Since Albert was erroneously excluded from the Plan, Albert’s missed deferral would be determined using the applicable ADP for 2008. In this case, Albert’s missed deferral is $1,200 (4% (ADP for NHCEs) multiplied by $30,000 (Albert’s compensation for 2008)). The corrective contribution required for Albert is $600 (50% multiplied by his $1,200 missed deferral).

Example 2: After receiving the Plan’s enrollment materials, Bobbi did not submit an election form. By not making an affirmative election in this automatic enrollment plan, Bobbi has expressed her desire to contribute at the Plan’s automatic enrollment deferral percentage of 3% of compensation. By failing to implement the Plan’s automatic enrollment provisions, the Plan did not execute Bobbi’s election. In this case, Bobbi’s missed deferral is $900 (3% (Bobbi’s elected deferral percentage) multiplied by $30,000 (Bobbi’s compensation for 2008)). The corrective contribution required for Bobbi is $450 (50% multiplied by her $900 missed deferral).

In both examples, the corrective contributions should be adjusted for earnings from the date that the elective deferrals should have been made through the date of the corrective contribution.

Finding the Mistake

Employers should periodically review the records of eligible employees who are not making elective deferrals to the plan. For these employees, plan records should contain affirmative elections requesting that the elective deferral be reduced from the automatic enrollment default percentage level to zero. In the absence of affirmative elections, it is likely that the plan failed to implement the plan’s automatic enrollment provisions.

Avoiding the Mistake

Plan administrators should determine which employees will be eligible to participate in the plan at the plan’s next entry date and ensure that they receive timely and complete information about the plan. The plan administrator and payroll provider should establish procedures so that the payroll provider has complete and updated information for eligible employees and their respective elections, as of the beginning of each pay period. The payroll provider must have a thorough understanding of the plan’s provisions with respect to elective contributions and make sure that its systems are consistent with plan design.

Page Last Reviewed or Updated: 25-Mar-2014