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 your 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 from not having a portion of compensation deferred on a pretax 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 you must make 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’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.
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. 2019-19 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 and 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. 2019-19, Appendix A.05(8) 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 2019-19.
Example with employer matching contributions:
Nancy met the plan’s eligibility requirements, but wasn't allowed to make elective deferral contributions to the plan four years ago. 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) and must be 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 five years ago. 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.
- Fixed employer contributions: Under the plan’s terms, Richard was also entitled to receive an employer contribution equal to 2% of compensation. 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) and must be adjusted for earnings through the date of correction.
Example for SIMPLE plan with Automatic Contributions Features Corrected In a Timely Manner:
Business XYZ (XYZ) maintains a SIMPLE plan that contains automatic contribution features. Per the terms of the plan, 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 2019, XYZ realized four employees hired in June of 2018, were improperly excluded from the SIMPLE plan due to an administrative error. XYZ discovered the failure in 2019 and auto-enrolled the employees in the SIMPLE plan as of April 1, 2019, and began withholding 3% of their compensation as salary reduction contributions to the plan. On May 1, 2019, XYZ issued a special notice to affected employees that satisfied the content requirement specified in Rev. Proc. 2019-19. 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 2018 and the first three months of 2019. The conditions of the Rev. Proc.2019-19, 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 the end of the plan year in which the failure first occurred (i.e. before October 15, 2019).
XYZ is still responsible to pay corrective contributions to the SIMPLE plan for any 2018 or 2019 matching contributions or employer contributions, if applicable, that the employees would have been entitled to under the terms of the SIMPLE plan.
Example for SIMPLE plan with no automatic contribution features corrected in a timely manner:
Assume the same basic facts from the above example, except that the terms of XYZ’s SIMPLE plan did not provide for automatic contributions. Assume the excluded employees become plan participants on April 1, 2018, and at that time were given the opportunity to participate in the SIMPLE plan. XYZ issued the special notice on May 1, 2018. Under these facts, the lost opportunity cost for the missed deferrals would be 25% of the missed deferral amount for 2018 and the first three months of 2019, 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. 2019-19. 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.
Example: Applicability of Rev. Proc. 2019-19 Appendix A.05(8) and .05(9) safe harbors to terminated employees:
Assume the same set of facts, 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:
Self-Correction Program (SCP):
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 for employee eligibility.
- The failure is insignificant.
Voluntary Correction Program (VCP):
If the plan isn’t under audit XYZ can make a VCP submission to the IRS under Revenue Procedure 2019-19 via the Pay.gov website following the procedures in Section 11. Plan sponsors are encouraged to make their VCP submission using model document Form 14568, Model VCP Compliance Statement (PDF), including Form 14568-D, Schedule 4 SIMPLE Plans (PDF) to identify the failure and describe how it’s being fixed. Note that the 0% or 25% correction method for missed deferral opportunity is not part of Form 14568-D. User fees for VCP submissions are generally based upon the current value of all IRAs that are associated with the SIMPLE plan.
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. 2019-19.
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.