SIMPLE IRA Plan Fix-It Guide – You used the wrong compensation definition to calculate deferrals and contributions to participants’ SIMPLE IRAs
Find the Mistake
Fix the Mistake
Avoid the Mistake
5) You used the wrong compensation definition to calculate deferrals and contributions to participants' SIMPLE IRAs.
Review the plan document to determine if you're using the proper compensation for deferrals and contributions.
Make corrective contributions to the plan to make up for the employees’ missed deferrals and contributions.
Review the plan’s definition of compensation to ensure that you’re using the correct amount to calculate deferrals and contributions.
Generally, compensation means the sum of a participant’s wages, tips and other compensation subject to federal income tax withholding and elective deferral contributions the participant made to the SIMPLE IRA plan.
How to find the mistake:
Review the computations for the elective deferral contributions and employer contributions for all employees. Make sure that you count all compensation (not just base compensation) in this review. Include bonuses, overtime, commissions and all other categories of compensation.
How to fix the mistake:
Make corrective contributions to employees’ SIMPLE IRAs equal to:
- 50% of the employee’s elective deferral percentage under the plan times the excluded compensation (Note: unlike the correction for excluded employees, in this case you know the participant’s actual salary deferral election); plus
- the employer contribution required under the plan times the excluded compensation.
You must adjust the amounts contributed for earnings to the date of correction. If it isn’t feasible to determine what the actual investment results would’ve 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.
Susan elected to make an elective deferral contribution of 5% of her compensation to the SIMPLE IRA plan. The plan terms require the employer to contribute 2% of compensation for each employee. However, when determining Susan’s elective deferral contribution and her required employer contribution, the employer neglected to add $1,000 of Susan’s overtime income to her $10,000 basic pay. Thus, Susan wasn't able to make elective deferral contributions on overtime income, and overtime income was ignored when determining the employer contribution that Susan was entitled to under the SIMPLE IRA plan.
The required corrective employer contribution must replace Susan’s missed opportunity to make elective deferral contributions on her overtime income plus any employer contributions to which Susan would be entitled under the plan terms.
- Missed deferral opportunity: Susan’s missed deferral, based on her election, is 5% times $1,000, or $50. The required corrective employer contribution to replace Susan’s missed deferral opportunity, before adjusting for earnings, is 50% of $50, or $25.
- Employer contributions: Under the terms of the plan, Susan was also entitled to receive an employer contribution equal to 2% of compensation. To replace the missed employer contribution on Susan’s $1,000 overtime income, the required corrective employer contribution is 2% times $1,000, or $20. The corrective contribution must also be adjusted for earnings.
The total corrective employer contribution is $45 ($25 missed deferral opportunity plus $20 employer contribution) and must be adjusted for earnings through the date of correction.
Correction programs available:
The example illustrates an operational problem because the employer failed to follow the terms of the SIMPLE IRA plan document in determining participant compensation. 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 for determining of participant compensation.
- The failure is insignificant.
Voluntary Correction Program:
If the plan isn’t 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:
Establish plan administrative procedures requiring an annual review of employees’ compensation. Verify that you have considered all compensation, including overtime, bonuses and commissions (not just base compensation) for determining employee elective deferral contributions and employer contributions.