December 31 Sunset of Safe Harbor Correction Method for Certain Elective Deferral Failures
A special IRS-approved correction method available for elective deferral failures in 401(k) and 403(b) plans with automatic contribution features will sunset on December 31, 2020, meaning it will not be available to correct elective deferral failures that begin after that date. It remains available, however, for a limited time to correct elective deferral failures that begin on or before that date. The loss of this favorable correction method going forward serves as a good reminder to plan sponsors to confirm that their plans, in operation, are correctly implementing employee elective deferrals.
Automatic contribution features have become an increasingly popular tool to expand the number of employees participating in 401(k) and 403(b) plans. These features may include automatically enrolling employees in the plan and automatically escalating employees’ deferral percentages on a set schedule. If not applied correctly, however, automatic contribution features may result in elective deferral failures. For purposes of this post, an elective deferral failure is a failure to implement elective deferrals correctly, including deferrals pursuant to an affirmative election or pursuant to an automatic contribution feature, and a failure to afford an employee the opportunity to make an affirmative election because the employee was improperly excluded from the plan.
Generally, 401(k) and 403(b) plan sponsors may correct elective deferral failures through the IRS’s Employee Plans Compliance Resolution System (EPCRS). This voluntary program permits plan sponsors to correct the mistake and avoid plan disqualification if the plan fully corrects the failure using a method that satisfies the requirements of EPCRS. Under EPCRS, the correction for elective deferral failures generally requires the employer to make a corrective contribution to make up for the missed elective deferral opportunity.
For the last five years, however, EPCRS has included a special safe harbor correction method available to 401(k) and 403(b) plans to correct elective deferral failures for eligible employees who are subject to an automatic contribution feature (IRS Rev. Proc. 2019-19, Appendix A § .05(8)). The IRS added the safe harbor correction method in response to complaints that existing correction methods were too burdensome, and were discouraging employers from adopting plans with automatic contribution features. Under this safe harbor correction method, no corrective contribution for missed elective deferrals is required if each of the following conditions is met:
- Correct deferrals begin no later than the affected employee’s first paycheck on or after the earlier of: (1) the end of the month after the affected employee notifies the employer of the failure; or (2) the last day of the 9-1/2 month period after the end of the plan year in which the failure first occurred. Because this correction method requires the employer to begin making correct deferrals, it is not available if the employee has terminated employment by the time correction is made.
- The employer gives the affected employee notice of the failure no more than 45 days after correct deferrals begin. The notice must satisfy the content requirements set forth in EPCRS.
- If the affected employee would have been entitled to matching contributions had the missed elective deferrals been made, the employer makes a corrective contribution equal to the matching contributions (adjusted for earnings) that would have been required as if the missed deferrals had been contributed to the plan.
This safe harbor correction is available as a method of self-correction, which means that a plan sponsor can use this method to correct a failure without notifying the IRS and submitting an application through the IRS’s Voluntary Correction Program.
This safe harbor correction method allows an employer to avoid making a corrective contribution for missed elective deferrals, which can make it an appealing alternative to EPCRS’s general correction method for elective deferral failures (which requires the employer to make a corrective contribution equal to 50 percent of the of the employee’s missed elective deferrals) and another safe harbor correction method (which requires the employer to make a corrective contribution equal to 25 percent of the employee’s missed elective deferrals).
The safe harbor correction method contains a sunset provision, however, and will not be available for any elective deferral failure that begins after December 31, 2020. When the IRS introduced the safe harbor correction method, the agency said it would consider in the future whether to extend it. To date, however, the IRS has not indicated that it will be extended. For elective deferral failures that are caught quickly, correction without having to make a corrective contribution for missed elective deferrals is still available under a separate safe harbor correction method for elective deferral failures that do not exceed three months.
The loss of the safe harbor correction method for elective deferral failures relating to automatic contribution features serves as a reminder to sponsors of 401(k) and 403(b) plans with automatic contribution features to confirm that these features are correctly implemented.
Please contact a member of our Employee Benefits & Executive Compensation Group if you have any questions about administering automatic enrollment or escalation features, or if you discover that employees have been improperly excluded from participating in your 401(k) or 403(b) plan.
Update (added December 4, 2020): Representatives from the IRS indicated during informal comments at the Quarterly Great Lakes TE/GE Council Meeting on December 4, 2020, that the IRS is considering extending EPCRS provisions that end on December 31, 2020. The representatives did not specify whether this includes the safe harbor correction method for elective deferral failures in 401(k) and 403(b) plans with automatic contribution features. If the IRS issues guidance extending the availability of the safe harbor, we will update this post accordingly.