Order of 401(k) Test Corrections
When a 401(k) plan faces multiple operational and compliance failures, the IRS sets the order of corrections.
Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Missouri is representative of a common question on the order of 401(k) testing corrections.
"My client’s 401(k) plan failed the actual deferral percentage (ADP) test and experienced a missed deferral opportunity. Which compliance issue should the plan correct first, and does the correction of one eliminate the need to correct the other?"
Highlights of the discussion
Your client should correct its 401(k) plan operational and compliance failures according to the IRS’s Employee Plans Compliance Resolution System (“EPCRS”), which can be found in Rev. Proc. 2021-30.
In the situation where a plan has both an ADP (1) testing failure and a missed deferral opportunity failure, the plan should correct the failed ADP before correcting for the missed deferral opportunity [See Rev. Proc. 2021-30, Appendix A .05(2)(g)]. If the highly compensated employee (HCE) receives a refund to correct the ADP testing failure, the amount of the refund would reduce the correction amount needed for any missed deferral opportunity.
In this specific case, the owner of the company, and only HCE, had a missed deferral opportunity because the plan failed to withhold deferrals from his bonus pay. The plan’s definition of compensation includes bonuses. In addition, the plan failed the ADP test. To correct the errors, the plan first corrected the ADP test failure by refunding $800 in deferrals to the owner. Second, the plan calculated the amount of the missed deferral opportunity, which was $350. Under EPCRS, the refund to correct the ADP test failure exceeded the amount needed to correct the missed deferral opportunity. Consequently, no additional amount was required for the missed deferral opportunity.
As a further note, any correction is subject to the Internal Revenue Code Sections (IRC§§) 402(g) and 415 limits for the year of the failure (and not the year in which the correction is made), so if the participant has exceeded either or both limits before the correction, no correction is required. See Rev. Proc. 2021-30, Section 6.02(4)(b); Appendix .05.
Conclusion
If a plan is facing multiple operational and compliance failures, corrections under EPCRS must address ADP/ACP testing failures first. Only after the plan resolves these issues can it apply corrections for missed deferral opportunities or other errors, ensuring that no participant exceeds the applicable contribution limits under IRC §§ 402(g) and 415.
(1) And/or actual contribution percentage (ACP)
