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Retirement Plan Basics – Missed Deferral Opportunities

One of the more difficult areas in retirement plan compliance is making sure that all eligible participants that wish to contribute to a retirement plan are given the opportunity to do so.  Tracking employee hire dates, plan eligibility requirements, and dispersing and retrieving deferral election forms create many potential roadblocks to plan compliance.  When an employee is eligible to participate in a retirement plan but is not allowed to do so because of administrative oversight, this creates what the Internal Revenue Service calls a missed deferral opportunity.

A missed deferral opportunity occurs when a plan sponsor mistakenly does not process a participant’s deferral election or precludes an eligible participant from participation in their retirement plan.  To correct for the missed deferral opportunity, the employer must make a qualified non-elective contribution (“QNEC”) to the participant’s account.  The QNEC must equal 50% of the deferral that was not made based on the participant’s compensation for the period in which the elective deferrals were not made, plus earnings.

IRS Revenue Procedure 2013-12 states that a missed deferral is determined by multiplying the actual deferral percentage for the year(s) of exclusion by the participant’s compensation for that year.  The actual deferral percentage will also rely on whether the participant should be classified as a Highly Compensated Employee or Non-Highly Compensated Employee.  The participant’s missed deferral amount may be reduced further to ensure it does not exceed applicable plan limits.

Further, if the participant should have been eligible for, but did not receive, an allocation of employer matching contributions under a non-Safe Harbor plan because the participant was not given the opportunity to make elective deferrals, the employer must make a corrective employer non-elective contribution on behalf of the affected employee.  The corrective employer non-elective contribution is equal to the matching contribution the participant would have received had the employee made a deferral equal to the missed deferral opportunity in the above paragraph, also adjusted for earnings.

For Safe Harbor Plans, the missed deferral is equal to the greater of 3% of compensation or the maximum deferral percentage for which the employer provides a matching contribution rate that is at least as favorable as 100% of the elective deferral made by the employee.  If the employee was not provided the opportunity to make elective deferrals, the missed deferral is deemed equal to 3% of compensation.  Therefore, the required QNEC on behalf of the excluded employee would be equal to 50% of the missed elective deferral, plus either an amount equal to the contribution that would have been required as a matching contribution based on the missed deferral in the case of a Safe harbor plan that uses a rate of matching contributions to match Safe Harbor requirements; or, the non-elective contribution that would have been made on behalf of the participant in the case of a Safe Harbor plan that would have been made on behalf of the participant for a Safe Harbor plan that uses non-elective contributions to satisfy Safe Harbor requirements.

Plan Sponsors must file an application under the IRS’ Voluntary Compliance Procedure to correct for missed deferral opportunities.  Failure to correct for a participant’s missed deferral opportunity may result in tax penalties and loss of the plan’s qualified status.