Default Correction Method – A Pain in the QNEC

The default correction method for elective deferral failures under 401(k) and 403(b) plans is set forth in Revenue Procedure 2013-12.  That Revenue Procedure describes an elective deferral failure as a failure to allow an employee to elect and make elective deferrals.  Rev. Proc. 2013-12, Appendix B, 2.02(1)(a)(ii)(B).  The default correction method involves making a qualified nonelective contribution (“QNEC”) on behalf of each affected participant to make up for missed deferral opportunities.  In most instances, the QNEC is equal to 50% of the amount the affected participant would have deferred if the failure had not occurred.  Additionally, the employer must make a corrective contribution equal to the full matching contribution the employee would have received adjusted for earnings.

Correction Without a QNEC
In response to a commonly-held view that the default correction method resulted in a windfall to affected participants, the Internal Revenue Service (the “Service”) issued guidance that allows for corrections without a QNEC for the elective deferral failure in certain instances.  See Rev. Proc. 2015-28.  In addition, the Service expanded the definition of an elective deferral failure to include the failure to implement elective deferrals pursuant to an automatic contribution feature, including an automatic escalation feature.  Rev. Proc. 2015-28, Section 3.04.  The instances where these corrections are permitted can be divided into two categories: automatic deferral failures and standard deferral failures.

Automatic Deferral Failures That do not Require QNECs
A plan sponsor is not required to provide a QNEC for a missed elective deferral related to the failure to implement an automatic contribution feature or the failure to implement an affirmative election of an eligible employee who is otherwise subject to an automatic contribution feature if the following conditions are met:

  • The plan sponsor corrected the failure within 9 ½ months after the end of the plan year in which the failure first occurred.
  • Correct deferrals began no later than the earlier of the 9 ½-month deadline set forth above or the first pay period after the last day of the month following the month in which a participant notified the employer of the failure.
  • The plan sponsor sent a specific notice to affected participants within 45 days after the correct deferrals began. The required contents for this notice are set forth in Revenue Procedure 2013-12.
  • The plan sponsor made a corrective contribution (which may be made from forfeitures), plus earnings, for the missed matching contributions by the end of the second plan year following the year in which the failure first occurred.

Standard Deferral Failures
In order to encourage early correction of employee elective deferral failures, the Service allows for the correction of certain elective deferrals without a QNEC.

No QNEC is required for an elective deferral failure affecting a participant not subject to automatic enrollment if:

  • Correct deferrals began no later than the earlier of the three-month from when the failure first occurred or the first pay period after the last day of the month after the month in which a participant notified the employer of the failure.
  • The plan sponsor sent notice to affected participants within 45 days after the correct deferrals begin. The notice must comply with the same content requirements as set forth in the automatic deferral failures.
  • The plan sponsor made a corrective contribution (which may be made from forfeitures), plus earnings, for the missed matching contributions by the end of the second plan year following the year in which the failure first occurred.

Reduced QNEC
Even if an elective deferral failure extends beyond three months, the plan sponsor may be permitted to make a reduced QNEC in the amount of 25% of the missed elective deferral.  In addition to the QNEC, the employer must make a corrective contribution for any matching contributions and earnings.  The reduced QNEC is available if all of the following criteria are met:

  • Correct deferrals began no later than the earlier of the first payment of compensation made on or after the last day of the second plan year following the plan year in which the failure occurred or the first pay period after the last day of the month after the month in which a participant notified the employer of the failure.
  • The plan sponsor sent notice to affected participants within 45 days after the correct deferrals begin. The notice must comply with the same content requirements as set forth in the automatic deferral failures.
  • The plan sponsor made a corrective contribution, including the 25% QNEC (which cannot be made from forfeitures) and employer contributions to make up for any missed matching contribution (which may be made from forfeitures), by the last day of the second plan year following the plan year for which the failure occurred.

If you have any questions, please contact our dedicated qualified plan team.

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