DEADLINES FOR CORRECTING 401(K) PLAN EXCESS CONTRIBUTIONS
One of the distinguishing requirements that sets 401(k) plans apart from other defined contribution plans are the contribution limits that apply to employee salary deferrals and company matching contributions.
Each year, 401(k) Plans must be tested to ensure that the actual deferral percentage (ADP) limit, the actual contribution percentage (ACP) limit and the IRC Sec. 402(g) annual deferral limits have been made within regulatory criteria:
- ADP failures—where the highly compensated employees (HCEs) defer too much in relation to the non-HCEs and create “excess contributions” [IRC Sec. 401(k)(8)(b)]
- ACP failures—where matching and/or after-tax contributions are too high for HCEs in relation to those for non-HCEs and create “excess aggregate contributions” [IRC Sec. 401(m)(6)(B)]
- 402(g) failures—where plan participants, either HCEs or non-HCEs, defer above the annual limit and create “excess deferrals” [IRC Sec. 402(g)(3)]
Amounts in excess of any one of these limits could have consequences for the employer, the participant and/or the plan as a whole, made more serious if excess contributions are not timely and properly corrected. Plan penalties are costly to plan sponsors and every effort should be made to avoid them.
IRS regulations include clear steps and deadlines by which companies that sponsor a 401(k) Plan must correct 401(k) excesses. If done so timely, a company can avoid additional penalties and potential plan disqualification. Corrections made after the specified deadlines must follow the terms of the IRS’s EPCRS. If the IRS disqualifies a plan, the plan sponsor loses the tax-saving benefits of the plan, and the assets become immediately taxable to the participants. Therefore, such excesses must be avoided and timely corrected when failures occur.
401(k) Excess Correction Deadlines |
Type of 401(k) Excess | Time of Correction | Consequences of Failing to Timely Correct |
Excess Contributions (ADP test failure where HCEs defer too much compared to non-HCEs) Or Excess Aggregate Contributions (ACP test failure where HCEs’ matching and or after-tax contributions are too high compared to non-HCEs’) | Within 2½ months after plan year end (March 15 for a calendar year plan) Issue corrective distributions to affected HCEs | Excess and earnings taxed in the year distributed |
After 2½ months after plan year end Two Corrective Options: 1. Issue corrective distributions to HCEs or 2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure | - Excess and earnings taxed in the year distributed
- Employer subject to a 10% penalty tax
|
After the end of the plan year following the year of the excess | - Employer subject to a 10% penalty tax
- Potential for plan disqualification
- Correct through Employee Plans Compliance Resolution System (EPCRS)
|
If “eligible automatic contribution arrangement” Excess Contribution or Excess Aggregate Contribution | 6 months following the end of the plan year (June 30 for calendar year plan) Issue corrective distributions to affected HCEs | Excess and earnings taxed in the year distributed |
After 6 months following the end of the plan year Two Corrective Options: 1. Issue corrective distributions to HCEs or 2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure | - Excess and earnings taxed in the year distributed
- Employer subject to additional 10% penalty tax
|
After the end of the plan year following the year of excess (December 31 for calendar year plan) | - Employer subject to additional 10% penalty tax
- Potential for plan disqualification
- Correct through EPCRS
|
Excess Deferrals (402(g) failure, Pre-Tax and Designated Roth) | On or before April 15 of year after deferral Issue corrective distributions of excess deferrals, plus their earnings | - Excess deferral taxed as income in the year deferred
- Earnings on excess taxed in the year distributed
|
After April 15 of year following excess | - Excess deferral taxed in the year deferred
- Both the excess deferral and earnings taxed in the year removed
- If excess deferrals result from deferrals to one or more plans maintained by the same employer, possible loss of qualified plan status
|
Learn more about designing your 401(k) Plan with a Safe Harbor Matching Contribution program so you can proactively pass the ADP/ACP tests: Why Consider a Safe Harbor Match vs. a Discretionary or No Match (smartertrack.com)
Additional information about these 401(k) Plan testing failures and how to correct such mistakes can also be found at 401(k) Plan Fix-It Guide | Internal Revenue Service (irs.gov). Your Leading Retirement Solutions team is here to help with questions and assistance. Request mid-year tests to proactively determine if ongoing contributions may result in testing failures come year end. Request pricing for mid-year testing by contacting our team.
Leading Retirement Solutions
(206) 430-5084 phone
(800) 974-2814 (toll free)
service@leadingretirement.com
www.leadingretirement.com
Our mission: to proactively support organizations and lead them toward a secure future.