Let’s take a nerdy dive into plan correction concepts! When correcting certain plan operational failures, a term that is frequently used is “missed deferral opportunity.” Not “missed deferrals,” but the “missed deferral opportunity.” This comes up when there has been some failure to make the appropriate deferrals to a participant’s account. Perhaps a participant’s deferral election, or a plan’s automatic deferral election, was never implemented, or implemented late. It could also be where insufficient deferrals were made, such as where an incorrect definition of compensation was used to calculate deferrals. In those situations, it is clear what the missed deferrals are, but what is the missed deferral opportunity?
Here’s a little background: One of the overarching correction principles of the IRS correction programs under the Employee Plans Compliance Resolution System (EPCRS) (most recently described in Rev. Proc. 2021-30) is to “restore the plan to the position it would have been in had the failure not occurred, including restoration of current and former participants and beneficiaries to the benefits and rights they would have had if the failure had not occurred.” In the distant past, the IRS-specified correction method required the employer to contribute 100% of the missed deferrals. The theory is that this would restore the plan to the position it would have been in had the deferrals been timely contributed on behalf of the participant in the first place. While this was technically correct, it also created a windfall for participants, as they already received the full un-deferred amount of their salary in their paychecks .
After sustained outcry from the retirement plan community, the IRS came up with a correction that would make participants “whole” by requiring a corrective contribution from the employer, not for the missed deferrals, but for the missed tax deferral opportunity that the deferral of compensation provides. This is what is meant by the missed deferral opportunity. While this may not technically restore the plan to the position it would have been in had the failure not occurred, it generously restores the participant to the benefit—the tax deferral opportunity—they would have had if the failure had not occurred.
The current correction method for these types of deferral failures requires that the employer make a corrective contribution equal to 50% of the missed deferrals. Note however, that any missed employer contributions have to be made as though 100% of the elected amounts were deferred.
Example:
Participant Angela Appleton elected to defer 10% of her compensation starting January 1, 2021. However, her employer discovered at the end of December 2021, that the payroll department had not started deferrals for Angela. They immediately started her deferrals as of January 1, 2022. In 2021, Angela made $36,000 and her deferrals should have been $3,600. Her employer’s plan provides for a matching contribution of 10% of deferrals and so her match should have been $360. In order to correct for the failure, Angela’s employer needs to contribute to Angela’s Plan account: $1,800 for the missed deferral opportunity (50% of $3,600) and $360 for the missed matching contribution (100% of the $360 in missed match). These amounts must be adjusted for earnings.
In some cases, where a deferral election failure is caught early enough, and other conditions are met (including specific notice requirements), the missed deferral opportunity can be reduced significantly:
- Where the failure to implement an automatic deferral contribution is corrected within 9 ½ months after end of the plan year in which the failure occurred, the missed deferral opportunity is reduced to 0% of the missed deferrals (note that this option currently sunsets as of December 31, 2023).
- Where the failure involves non-automatic deferrals, and is corrected within three months from the date the failure began, the missed deferral opportunity is reduced to 0% of the missed deferrals.
- Where the failure involves non-automatic deferrals, but was not corrected until after three months from date the failure began but within the 3-year self-correction period, the missed deferral opportunity is reduced to 25% of the missed deferrals.
The IRS has deemed that under these limited situations, the missed deferral opportunity is reduced because of the quick correction, and perhaps because of a reduction in reliance on the deferral opportunity in an automatic deferral situation.
Note that no matter how quickly a deferral election failure is corrected, applicable employer contributions must always be contributed at 100% of the missed amount, and earnings must also be calculated and contributed.
If you have questions about this, or other corrections issues, our attorneys are experienced in determining appropriate plan corrections, and are available to help.