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.
Other IRS safe harbor correction methods may be acceptable to fix this mistake. For failures found and fixed promptly, plan sponsors have the option to reduce the corrective employer contribution for the lost opportunity cost from 50% of the missed deferral to 25% under the following conditions:
- The excluded employee must be currently employed by the employer at the time of correction
- The period of failure exceeds three months
- Correct deferrals finally begin by the first payment of compensation made on or after the earlier of:
- The last day of the second plan year after the plan year in which the failure first began for the affected employee, or the last day of the month after the month the affected eligible employee first notified the plan sponsor; and
- Within 45 days of being given the opportunity to make salary reduction contributions (or the commencement of auto-enrollment contributions), the affected participant must receive a special notice. See Appendix A.05(9) discussed in Rev. Proc. 2016–51 for details as to the specific content that must be in this notice. If the participant terminates employment before the notice is provided then this requirement has not been met.
If the period of failure is less than three months, no corrective contribution for the missed deferral opportunity is required. The excluded employee must begin to participate in the plan. If the plan provided for auto-enrollment, the commencement of deferrals occurs within the three-month period beginning from the start of the failure and the issuance of the special notice occurs within the 45-day timeframe.
All other corrective contributions must be paid to the employee’s SIMPLE IRAs before the end of the 2nd plan year beginning after the initial year of the failure.
For SIMPLE plans with automatic contribution features (i.e. auto-enrollment and auto-escalation), the corrective contribution for the missed deferral opportunity is reduced to zero if correct deferrals begin by the first payment of compensation made on or after the earlier of:
- 9½ months after the end of the plan year in which the failure first occurred, or
- the last day of the month after the month the affected employee first notified the plan sponsor of the error.
The special notice to the affected employee must be provided within the applicable 45-day timeframe. See Rev. Proc. 2016-51 for additional details. This special 0% rule only applies to failures occurring before 2021. The plan sponsor is still responsible for providing correcting matching contributions or missed employer contributions to the IRAs associated with the SIMPLE plan within the two-year timeframe used to correct significant operational failures under Revenue Procedure 2016-51.
Business XYZ (XYZ) maintains a SIMPLE plan that contains automatic contribution features. Per plan terms, there is no minimum age or service requirements for eligibility. In this case, all employees in the SIMPLE plan automatically have salary reduction contributions of 3% of compensation withheld from their pay. Participants may decrease or increase this amount by filing an affirmative, written election. In 2016, XYZ realized four employees hired in June of 2015 were improperly excluded from the SIMPLE plan due to an administrative error. XYZ discovered the failure in 2016 and auto-enrolled the employees in the SIMPLE plan as of April 1, 2016, and began withholding 3% of their compensation as salary reduction contributions to the plan. On May 1, 2016, XYZ issued a special notice to affected employees that satisfied the content requirement specified in Rev. Proc. 2016-51. XYZ does not have to provide a corrective contribution for the missed opportunity to make salary reduction contributions due to the employees’ improper exclusion from the plan in 2015 and the first three months of 2016. The conditions of the Appendix .05(8) safe-harbor were met when:
- improperly excluded employees were enrolled;
- special notice was provided within the applicable 45 day period; and
- the above actions occurred within 9 ½ months after end of the plan year in which the failure first occurred (i.e. before October 15, 2016).
XYZ is still responsible to pay corrective contributions to the SIMPLE plan for any 2015 or 2016 matching contributions or employer contributions, if applicable, that the employees would have been entitled to under the terms of the SIMPLE plan.
Assume the same basic facts from example 2, except that the terms of the XYZ’s SIMPLE plan didn’t provide for automatic contributions. Assume the excluded employees become plan participants on April 1, 2016, and at that time were given the opportunity to participate in the SIMPLE plan. XYZ issued the special notice on May 1, 2016. Under these facts, the lost opportunity cost for the missed deferrals would be 25% of the missed deferral amount for 2015 and first three months of 2016, adjusted for earnings through the date of correction. This is permitted because XYZ complied with the special safe harbor requirements in the Appendix A.05(9) safe harbor discussed in Rev. Proc. 2016-51. XYZ would still owe 100% of the any owed corrective contributions associated with matching or non-elective employer contributions, if applicable, and all corrective contributions would have to be paid to the SIMPLE plan before the end of the 2nd plan year beginning after the initial year of the failure.
Assume the same set of facts as example 2, except that one of the XYZ’s excluded employees terminated in March of 2016. Then none of the special safe harbors in Appendix A.05(8) or .05(9) would be applicable to the terminated employee because the conditions discussed in Rev. Proc. 2016-51 can’t be met because the employee is no longer employed by XYZ at the time of correction. Therefore, the lost opportunity cost for the missed deferrals would be 50% of the missed deferral amounts for this employee, adjusted for earnings through the date of correction. XYZ would still owe 100% of the any owed corrective contributions associated with matching or non-elective employer contributions, if applicable, and all corrective contributions would have to be paid to the SIMPLE plan.
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 Form 14568, Model VCP Compliance Statement, including Form 14568-D, Model VCP Compliance Statement - Schedule 4: SIMPLE IRAs. Include Forms 8950 and 8951. The user fee for the VCP submission is $250. Note that the 0% or 25% correction method for missed deferral opportunity is not part of Form 14568-D.
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 plan sponsor and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction that is not excessive, considers facts and circumstances, and bears a reasonable relationship to the nature, extent and severity of the failures, based upon all relevant factors described in section 14 of Rev. Proc. 2016-51.
How to avoid the mistake:
Establish plan administrative procedures requiring an annual review of employees’ compensation. Verify that you've considered all compensation, including overtime, bonuses and commissions (not just base compensation) for determining employee elective deferral contributions and employer contributions.