What happens when there’s a mistake in your 401(k) plan? Overview of the IRS correction program
The IRS understands that no plan runs smoothly all the time. Errors happen due to system failures, human error, and gaps in procedures. But the IRS does expect plan sponsors to fix mistakes or risk plan disqualification. As with most aspects of your plan, having documented procedures can make the correction process smoother and more efficient.
Steps to correct retirement plan errors
Administrative mistakes happen no matter how diligent you are. Following this four-step process can help you address them promptly and minimize the negative effects:
1 Identify the type and severity of the mistake
2 Determine which IRS correction program to use
3 Fix the error according to the terms of the selected IRS program
4 Review and update policies and procedures to help prevent a reoccurrence
Let’s take a closer look at each of these steps.
Identify the type and severity of the mistake
Errors can lead to plan disqualification, which can have significant ramifications for the plan sponsor and participants. The plan sponsor loses the tax deduction for any employer contributions, and all participant contributions and any earnings are immediately taxable to participants—a scenario no one wants. Make sure you conduct regular internal plan audits to identify any issues before the IRS finds them.
Common plan errors include:
- Missing or late required minimum distributions
- Plan loan violations and impermissible hardship withdrawals
- Failure to use correct definition of plan compensation
- Incorrect profit-sharing contribution allocation
- Actual deferral percentage (ADP) test failure not corrected by IRS deadline
- Excluding eligible employees
If you discover errors—one of the above or others—you’ll want to determine:
- The reason for the failure
- The number of participants and beneficiaries affected
- The percentage of plan assets or contributions involved
- The duration of the mistake
The answers to these questions will help you determine the severity of the issue and possible correction methods.
Determine which IRS correction program to use
The IRS created the Employee Plans Compliance Resolution System (EPCRS) (see IRS Revenue Procedure 2021-30) to encourage sponsors to correct mistakes and avoid potential plan disqualification. EPCRS is a program of programs designed to address different situations. The three IRS correction programs are:
|
Self-Correction Program (SCP) |
Voluntary Correction Program (VCP) |
Audit Closing Agreement Program (Audit Cap)
|
Voluntary or involuntary |
Voluntary |
Voluntary (effective January 1, 2022, anonymous submissions aren’t permitted)
|
Involuntary (mandated by the IRS) |
Type of defect |
Insignificant operational failures and significant operational failures corrected no later than the last day of the third plan year following the plan year in which the failure occurred
Eligible operational failures include:
Document failures aren’t eligible for self-correction |
Significant operational failures that don’t qualify for SCP or document failures
|
Serious operational, plan document, and nondiscrimination (demographic) failures uncovered by the IRS during a plan audit |
IRS filing fees |
None |
Ranges from $1,500 to $3,500, depending on net plan assets (some exceptions may apply)
|
N/A |
IRS sanctions |
None |
None |
A negotiated percentage of the full tax liability the plan sponsor would owe if the plan was disqualified |
The U.S. Department of Labor offers self-correction programs for mistakes not covered under EPCRS:
- The Delinquent Filer Voluntary Compliance Program for failing to file or filing late Form 5500s
- The Voluntary Fiduciary Correction Program for late 401(k) deposits and other fiduciary breaches
Follow the established correction process
The goal of the IRS correction programs is to ensure the fair and right thing is done on behalf of all participants. While each program has its own process for achieving this goal, they share these common tenets:
- The failure isn't considered fixed until it's fully corrected for all affected participants and beneficiaries for all affected tax years.
- The plan sponsor must use a correction method that's reasonable and appropriate.
- The plan must be restored to the position it would have been in had the defect not occurred.
Each correction option has its own set of general requirements. Plan sponsors should work closely with their ERISA attorneys and other plan advisors to determine which program to use and to make sure the process is followed properly.
SCP |
|
VCP |
|
Audit CAP
|
|
Review and update policies and procedures
Once the plan defect is fixed, you’ll want to prevent it from happening again. Use this opportunity to:
- Conduct a thorough review of your policies and procedures to make sure processes, roles, responsibilities, and key dates are clearly documented.
- Test your systems to make sure they accurately reflect your plan provisions.
- Conduct refresher training for all involved with the plan’s operations.
You want to have all three—documentation, systems, and people—working in sync to help you minimize errors and keep your plan compliant.
The IRS correction program is ever evolving
The IRS continues to revise EPCRS to clarify and improve the self-correction, voluntary correction, and audit cap programs, issuing revised procedures every few years. Be sure to reach out to your plan’s advisory team for assistance if you uncover a plan defect. The team can help you determine the best course of action based on the most current IRS guidance.
Important disclosures
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.
MGTS-P-44874-GE 05/21-44874 MGR0908211819247