SIMPLE IRA Plan Fix-It Guide – You excluded an eligible employee from participating
Find the Mistake
Fix the Mistake
Avoid the Mistake
4) You excluded an eligible employee from participating.
Review plan document sections on eligibility and participation. Check whether you enrolled employees at the proper time.
Make corrective contributions to place affected employees in the position they would have been in if no mistake was made.
Review the participation status of all employees at least annually.
Generally, any employee is eligible to participate if:
- you reasonably expect the employee to receive at least $5,000 in compensation during the calendar year, and
- the employee did so in any prior 2 years.
You may increase the number of employees eligible to participate by lowering the $5,000 amount or by allowing all employees to participate regardless of how much they earn.
How to find the mistake:
Review the SIMPLE IRA plan document to determine which employees you must allow to participate. Compare past payroll information with employees who participated in the SIMPLE IRA plan. For example, if the plan uses the strictest participation rule, begin with the following spot check:
- Review payroll data (W-2s, quarterly returns filed with the state (if applicable) and internal payroll records for prior years).
- List all employees who earned at least $5,000 during any two prior years and whom you employed for any part of the current year.
- Determine if any of those employees didn't make elective deferrals or receive an employer contribution in the prior years or the current year.
- For the group of employees who either didn't make elective deferrals or receive an employer contribution, determine whether their failure to make elective deferrals or receive employer contributions was because of their exclusion from the plan.
- If employees were excluded from the plan, determine if the exclusions were consistent with the plan’s terms.
- If you find any employees in your spot check who were improperly excluded, then this could be an indication of a larger problem. You might expand the search to include other employees. This might require a review of past years' payroll data.
How to fix the mistake:
If you excluded an eligible employee, you must make up for the employee’s “missed deferral opportunity” by making a contribution of 1.5% of compensation for the period of the employee’s exclusion, plus earnings (calculated from the date that the elective deferrals should have been made through the date of correction). The “missed deferral opportunity” is the economic loss to the employee resulting from not having a portion of compensation deferred on a pre-tax basis to a retirement account in which the amounts deferred can accumulate tax-free. Since the employee didn’t have a chance to make an election, IRS safe harbor correction methods assume that the employee would’ve elected to defer 3% of compensation. The required corrective contribution to replace the missed deferral opportunity is 50% of the missed deferral, or 1.5% of compensation.
If, under the plan, the employer contribution is a 3% match, then the corrective contribution should include a matching contribution of 3% of compensation plus earnings (calculated from the date that you should have made the required contributions through the date of correction). If the improperly excluded employee made the 3% of compensation elective deferral, as assumed in the prior paragraph, then the employee would’ve received a matching contribution equal to 3% of compensation. (Note: This contribution is in addition to the corrective contribution made to replace the “missed deferral opportunity.”)
If, under the plan, the employer contribution is a 2% nonelective contribution (not dependent on the elective deferrals made by employees), then the corrective contribution should include a contribution of 2% of compensation plus earnings (calculated from the date the required contributions should have been made through the date of correction). If it isn’t feasible to determine what the actual investment results would have been, you may use a reasonable rate of interest, such as the interest rate used by the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator (see Revenue Procedure 2013-12 sections 6.11(4) and 6.02(5)(a)).
Example with employer matching contributions:
Nancy met the plan’s eligibility requirements, but wasn't allowed to make elective deferral contributions to the plan. Nancy earned $10,000 during the year she was excluded. Under the plan document, the employer selected a matching contribution equal to each eligible employee’s elective deferral contributions up to 3% of compensation.
The required corrective employer contribution must replace Nancy’s missed opportunity to make elective deferral contributions plus any employer contributions to which Nancy would be entitled under the plan’s terms.
- Missed deferral opportunity: Nancy’s missed deferral is 3% times $10,000, or $300. The required corrective employer contribution to replace Nancy’s missed deferral opportunity, before adjusting for earnings, is 50% of $300, or $150.
- Employer matching contributions: Under the plan’s terms, Nancy would've been entitled to an employer matching contribution equal to 3% of compensation based on her 3% missed deferral. The required corrective employer contribution to replace the missed matching contribution is 3% times $10,000, or $300, adjusted for earnings.
The total corrective employer contribution is $450 ($150 missed deferral opportunity plus $300 employer contribution) adjusted for earnings through the date of correction.
Example with fixed employer contributions:
Richard met the eligibility requirements, but his employer didn't permit him to make elective deferral contributions to his SIMPLE IRA plan. During the year of exclusion, Richard earned $10,000 in compensation. The terms of the SIMPLE IRA plan require an employer contribution for each eligible employee equal to 2% of the employee’s compensation for the calendar year.
The required corrective employer contribution must replace Richard’s missed opportunity to make elective deferral contributions plus any employer contributions to which Richard would be entitled under the plan’s terms.
- Missed deferral opportunity: Richard’s missed deferral is 3% times $10,000, or $300. The required corrective employer contribution to replace Richard’s missed deferral opportunity, before adjusting for earnings, is 50% of $300, or $150. Thus, the required corrective contribution for an employee the employer improperly excluded from making elective deferrals to a SIMPLE IRA plan is equal to 1.5% of compensation (adjusted for earnings through the date of correction).
- Fixed employer contributions: Under the plan’s terms, Richard was also entitled to receive an employer contribution equal to 2% of compensation. Thus, to replace the missed employer contribution, the required corrective employer contribution is 2% times $10,000, or $200, adjusted for earnings through the date of correction.
The total corrective employer contribution is $350 ($150 missed deferral opportunity plus $200 employer contribution) adjusted for earnings through the date of correction.
Correction program(s) available:
The examples illustrate an operational problem because the employer failed to follow the terms of the SIMPLE IRA plan document by excluding eligible employees from participating in the plan. If the other eligibility requirements of SCP are satisfied, the employer might be able to use SCP to correct the mistake. The employer would have to determine whether:
- Appropriate practices and procedures were originally in place to facilitate compliance with requirements regarding employee eligibility.
- The failure is insignificant.
Voluntary Correction Program:
If the plan is not under audit, you may make a VCP submission using the model documents in Appendix C, including Schedule 4. You must include Forms 8950 and 8951.The fee for the VCP submission is $250.
Audit Closing Agreement Program:
If this mistake is discovered on audit, it may be corrected under Audit CAP. Correction of the plan under Audit CAP should be very similar to correction under SCP. The sanction under Audit CAP is a percentage of the maximum payment amount.
How to avoid the mistake:
Before adopting a SIMPLE IRA plan, understand its features and determine whether the participation requirement for this type of plan matches your goals. In a SIMPLE IRA plan, you have limited flexibility to customize the plan participation criteria.
The individuals who administer the plan should be familiar with the terms of the plan document and there should be sufficient plan administrative procedures to ensure that the eligible employees are allowed to participate in the plan.
Before each November 2, take inventory of the individuals currently excluded from participation in the plan and compare with the plan terms. If you determine that any of the excluded employees will be eligible in the following calendar year, then you should provide notices informing the participants of their rights to make elective deferral contributions before the election period that begins on November 2.
Make sure you consider all employees of any controlled group or affiliated service group and leased employees in determining the group of employees who should have the opportunity to make elective deferral contributions and receive employer contributions under the plan.