Fixing Common Plan Mistakes - Failure to Provide a Safe Harbor 401(k) Plan Notice
A safe harbor 401(k) plan requires the employer to provide:
timely notice to eligible employees informing them of their rights and obligations under the plan and
certain minimum benefits to eligible employees either in the form of matching or nonelective contributions.
The employer should provide the rights and obligations notice within a reasonable period before the beginning of each plan year (or in the year an employee becomes eligible, within a reasonable period before the employee becomes eligible). In general, the law considers notices timely if the employer gives them to employees at least 30 days (and no more than 90 days) before the beginning of each plan year. The notice must include, at a minimum, details on:
whether the employer will make matching or nonelective contributions,
other contributions under the terms of the plan,
the plan to which the safe harbor contributions are made, if more than one plan,
the type and amount of compensation that may be deferred under the plan,
how to make cash or deferred elections,
the specific time periods available under the plan to make cash or deferred elections,
withdrawal and vesting provisions for plan contributions, and
how to easily obtain additional information about the plan (including a copy of the summary plan description).
Rainbow Company established a safe harbor 401(k) plan in 2005. The plan provides for matching contributions in an amount equal to: 100% of elective contributions up to 3% of the employee’s compensation plus 50% of elective contributions greater than 3%, but not more than 5% of the employee’s compensation. Eligible employees received timely notices in 2004, 2005, and 2006. However, in 2007 Rainbow failed to provide safe harbor notice to its employees. In addition, Rainbow did not furnish notices to employees who became eligible to participate in the plan in 2008. Rainbow discovered the problem when it conducted an internal review of its plan operations at the end of 2008.
Violet first became eligible to participate in the plan on January 1, 2008. She did not receive notice and Rainbow did not inform her of her right to make elective contributions to the plan. She earned $20,000 in compensation in 2008.
Indigo has been a participant in the plan since 2005. She has made elective contributions of 2% of compensation each year, after receiving notices in 2004, 2005, and 2006. While she did not receive a notice in 2007, the human resource department (HR) informed her that the employer’s matching contribution formula will remain the same for 2008 and that she should inform HR if she wanted to make any changes to her elective contributions for 2008.
Finding the Mistake:
In order to find the mistake, review:
The deferral decisions among eligible employees. If many eligible employees are either not making elective contributions or deferring at low rates, it is possible that they did not have timely access to the information contained in the notice.
The plan’s procedures for issuing notices.
The plan’s records showing that the employer followed the plan’s procedures relating to the distribution of notices.
Fixing the Mistake:
Rainbow must evaluate the impact of its failure to provide notice to its eligible employees. The solution might be different for each affected employee. As illustrated in this problem, the failure to provide notice could require correction for the exclusion of an eligible employee or a simple revision to an administrative procedure.
Exclusion of an eligible employee. Violet belongs in this category. Due to its failure to provide notice, Rainbow did not inform Violet of her ability to make an elective contribution when she was eligible. To correct the failure, Rainbow must make a corrective contribution for Violet to replace her missed deferral opportunity and the missed matching contributions that occurred because Rainbow improperly excluded her from the plan. The corrective contributions are determined as follows:
(a) Missed deferral opportunity: If an employee is not provided with the opportunity to elect and make elective deferrals to a safe harbor §401(k) plan that uses a rate of matching contributions to satisfy the safe harbor requirements of §401(k)(12), then the missed deferral is deemed equal to the greater of 3% of compensation or the maximum deferral percentage for which the employer provides a matching contribution rate that is at least as favorable as 100% of the elective deferral made by the employee. Violet’s missed deferral is 3% of her compensation of $20,000, or $600. Violet’s missed deferral opportunity is 50% of her missed deferral of $600, or $300. Rainbow needs to make a corrective contribution to replace Violet’s missed opportunity to make elective contributions of $300 (adjusted for earnings).
(b) Missed matching contribution: If Violet made an elective deferral of $600, she would have received an employer matching contribution of $600. Rainbow needs to make a corrective contribution to replace the missed matching contribution of $600 (adjusted for earnings).
Fixing an administrative problem. Indigo belongs in this category. The failure to provide notice did not prevent her from making an informed timely election to change (or maintain) her elective contribution to the plan. No corrective contribution for Indigo is required. The plan needs to reform its procedures to ensure that she receives timely notices in the future.
Correction Program(s) Available:
Rainbow may use the correction programs described in Revenue Procedure 2013-12 to correct the mistake.
Avoiding the Mistake:
Employers should maintain a calendar for due dates by which certain tasks need to be completed. In the case of a safe harbor 401(k) plan, this includes the timely distribution of notices to eligible employees.