In the last few years, the IRS has been broadening the opportunity for self-correction under its Employee Plans Compliance Resolution System (known as “EPCRS”). Recent expansions include a longer period in which even significant failures can be self-corrected, and the ability to retroactively adopt some amendments and restatements without filing a voluntary correction program (“VCP”) submission with the IRS. This trend continues under the SECURE Act 2.0 of 2022 (“SECURE 2.0”).
In SECURE 2.0, there are three sections related to plan failure corrections, and they all increase self-correction opportunities:
Automatic Enrollment Deferral Failure Safe Harbor–Now Made Permanent. Since 2015, the IRS has provided a safe harbor self-correction method for auto-enrollment failures in a 401(k) or 403(b) plan. A corrective contribution for the missed deferrals is not required as long as:
- Deferrals are started within 9 ½ months after the end of the plan year in which the failure started; and
- Specific notice requirements are met; and
- Any missed matching contributions are contributed, plus earnings.
Before SECURE 2.0, this generous safe harbor was set to sunset on December 31, 2023, but now it is securely secured by SECURE 2.0. Sorry, couldn’t resist.
SECURE 2.0, has finally made this provision permanent, which is a welcome relief for employers who use an auto enrollment feature. This is especially good timing for this relief, as SECURE 2.0 requires all new plans (adopted on after December 29, 2022) to include an automatic enrollment feature starting in 2025.
Inadvertent Overpayment Recovery May be Avoided. One common operational failure is the excess payment of benefits. In the past, in keeping with the EPCRS principle that the plan must be made whole, plans were required to zealously pursue former participants for full repayment regardless of circumstances. This could result in the financial hardship for the former participant. SECURE 2.0 addressed this harsh result by immediately establishing a new rule that return of the overpayment need not be pursued. It will not be considered a breach of fiduciary duty, nor a failure of qualification requirements under the Internal Revenue Code. In addition, the recipient of the overpayment may continue to treat the overpayment as eligible for tax deferred for purposes of rollover.
If recovery of an overpayment is pursued, the plan fiduciary (and the former participant) must be aware of the following limitations:
- Time Limit. Recovery cannot be sought if the first overpayment occurred more than three years before the participant or beneficiary is notified in writing of the error, except in the case of the participant’s fraud or misrepresentation.
- Death of Participant Ends Recovery. Recovery cannot be sought from the participant’s surviving spouse or beneficiary.
- No Interest/Costs. Interest and collection costs/fees cannot be charged on the overpayment.
- Amount Limits. The amount recouped each calendar year by reducing annuity payments or permitting installment payments cannot be more than 10% of the full amount of the overpayment. Recoupment by reduction of future benefit payments cannot reduce the future benefit payments below 90% of the normal payment amount and payments must go back to 100% as soon as the overpayment has been recovered.
- No Threats of Litigation/Collection Agencies. Litigation cannot be threatened in an attempt to recover the overpayment, unless the responsible fiduciary determines that the plan is likely to recover more than the cost of recovery. In addition, collection agencies may generally not be used.
- Participant May Contest. Participants may contest the attempt at recoupment under the plan’s claims procedures.
- Additional Rules to Come. Recovery of overpayments other than in connection with an annuity must comply with rules to be issued by the Department of Labor in the future.
Expansion of Self-Correction of Failures. EPCRS used to limit self-correction to insignificant failures and significant failures that were corrected within a short period of time. In recent years, the IRS has loosened these requirements permitting retroactive amendments to correct certain failures, and extending the period for correction of significant failures from two years to three years.
- Inadvertent Failures. Under SECURE 2.0, any “eligible inadvertent failure” may be self-corrected. This term is defined broadly as any plan failure to meet the requirements of Code Sections 401(a), 403(a), 403(b), 408(p, or 408(k) that occurs despite the existence of a plan sponsor’s practices and procedures reasonably designed to promote compliance consistent with EPCRS. This means, at the very least, plan sponsors will need to establish that they have such practices and procedures in place, and that the failure occurred despite them.
- Loan Failures. In addition, correction of some inadvertent loan failures, including those that previously had to be submitted to the IRS for approval (under the Voluntary Correction Program or Audit Closing Agreement Program), can now be self-corrected.
This helpful broadening of self-correction is effective immediately, even before the IRS updates the EPCRS revenue procedure, which must be completed within two years.
Obviously, in an ideal world, the best plan of action is to make sure the plan stays in compliance and not experience qualification failures. But in the real world, failures happen despite good intentions and even diligence. The ability to self-correct is often preferable as it avoids the costs and fees (or sanctions if under audit) of getting IRS approval. Whenever pursuing a self-correction it is always critical to document and explain the rationale for self-correction eligibility and the method of correction chosen.