Ineligible Contributions and Corrective Options
By Luke Swanson, QKA, CIP
What causes a plan to have an ineligible contribution failure?
A number of situations can cause an ineligible contribution failure. These include, but are not limited to, the following.
A participant was enrolled into the plan before attaining eligibility and reaching an entry date.
Example: The plan document has an age and service requirement of age 21 and one year of service. A participant who did not yet work one year is entered into the plan and contributes or receives an employer contribution.
An employee (or employer) who is excluded from the plan is allowed to participate.
Example 1: The plan document excludes leased employees; however, a leased employee is allowed to participate
Example 2: A related employer, part of a controlled group of businesses, is participating in the plan, but the plan document was never amended to formally include them.
An employer withheld too much from a participant’s pay.
Example: A participant changed their deferral rate from 10% to 0%; however, 10% is still withheld from the participant’s pay and remitted to the plan.
A last day and/or hours requirement was not met by a participant.
Example: The plan document requires that participants be employed on the last day of the plan year and work at least 1,000 hours in the plan year to receive an employer matching or profit sharing contribution. A participant who has been receiving matching contributions per payroll terminates from employment mid-year with only 800 hours of service.
NOTE: If a plan contains a service and/or last day requirement to receive an employer contribution, it may avoid this failure by providing the contribution after the plan year is over, rather than on a payroll-by-payroll basis.
An ineligible rollover contribution was made to the plan by a participant.
Example: A participant completed a rollover contribution into the plan, but the assets were either not eligible to be rolled over into the plan (e.g., came from a nonqualified source), or the participant completed the rollover after her 60 day rollover window had expired.
What options are available for a plan to correct an ineligible contribution failure?
Corrective options for a plan include the following.
Distribute ineligible deferral contributions out of the plan to the affected participant and move any corresponding matching contributions to the plan’s suspense account (to be used toward reducing the next employer contributions). Ineligible deferrals and matching contributions should be adjusted for earnings before being removed.
NOTE: This corrective method may require the ADP/ACP test to be adjusted and re-generated.
Remove ineligible contributions and place them into the plan’s suspense account (to be used toward reducing the next employer contributions). If deferrals are involved, this method may still be used. It’s most practical when ineligible deferrals occur in the same year as the correction so that the participant’s current year IRS Form W-2, Wage and Tax Statement, can be adjusted to reflect the deferrals that were moved to the plan’s suspense account instead of being distributed. Ineligible deferrals and matching contributions should be adjusted for earnings before being removed.
NOTE: This corrective method may require the ADP/ACP test to be adjusted and regenerated.
Retroactively amend the plan under the IRS’ Self-Correction Program (SCP) to change eligibility age, eligibility service, or plan entry date requirement(s); in effect, making the contributions legitimate.
NOTE: This is not an available correction method if it causes a second plan failure. For example, all participants were required to complete one year of service as elected in the plan document, but one participant was allowed to participate early after six months of service. Retroactively amending the plan’s service requirement to six months of service would cause another failure for those participants required to complete one year of service, and therefore is not recommended. If instead all participants had been allowed to enter the plan after six months of service, despite a plan document requirement of one year, then a retroactive amendment under SCP to change the service requirement to six months would be allowable, as no secondary failure would be created.
Retroactively amend the plan under the IRS’ Voluntary Correction Program (VCP) for changes other than eligibility age, eligibility service, or entry date requirement(s).
NOTE: This is not an available correction method if it causes a second plan failure.
Example: The plan document was not amended to include a related employer component of a controlled group of businesses, although the employees of the related employer properly received all plan disclosures and have been participating all along.