Help! I Made a Mistake on the Definition of Compensation… How Do I Correct It?
Mistakes and errors (referred to in practice as “operational defects”) in employee benefit plans CAN and DO occur. One of the most common plan mistakes is the failure to use the correct definition of compensation, as defined by the plan document. A plan document may have multiple definitions of compensation including compensation used as a basis to calculate salary deferrals, matching contributions, and employer discretionary contributions. Careful analysis of the plan document to determine what the specific definitions are regarding employee deferrals and employer contributions can serve to prevent this type of mistake. As a result of using the incorrect definition of compensation, a plan will have incorrect participant deferrals, incorrect employer matching contributions, or incorrect discretionary employer contributions -- or possibly all three -- depending on the provisions of the plan.
Such errors are caused by many things. The error may be as a result of the third party administrator or payroll processor not being aware of the current correct definition; or the payroll system not being properly set up initially or updated in a timely manner to reflect the proper definition when a change occurred. It may be that the plan’s definition of compensation was amended and not communicated to the proper service providers or personnel; or it could be as simple as not reading the plan document to even consider the compensation to be used! The discrepancy that arises in the participants’ accounts may be an overstatement or understatement; yet in either case, it is considered an error that must be investigated and corrected.
When the provisions of a qualified plan are not followed, such as using the incorrect definition of compensation, it constitutes an operational defect, sometimes referred to as an operational failure. The bad news is that it must be fixed and the participants must be made whole. In other words, the participants’ account balance must be restored to the proper balance as if the error did not occur. The good news is that there are programs that offer plan sponsors the chance to identify and fully correct certain transactions and bring their plan into compliance. A plan sponsor has the ability to correct these errors using an IRS retirement plan correction program known as the Employee Plans Compliance Resolutions System (EPCRS), outlined in Revenue Procedure 2013-12. There are also Fix-it Guides available from the IRS, for 401k plans and 403(b) plans, accessible at http://www.irs.gov/Retirement-Plans/401(k)-Plan-Fix-It-Guide. It is strongly recommend that you consult with your ERISA attorney to determine the best correction method to use.
This type of operation defect is one that could be the most significant, take the most time to quantify, and be the most costly to the plan sponsor. To avoid such an error, review your plan document on an ongoing basis to ensure plan provisions are followed.