Imperfect defined contributions plans: When good plans go bump

Defined contribution retirement plans are a complex entanglement of many moving parts and players that can change at any moment. Internal Revenue Service (IRS) and U.S. Department of Labor (DOL) regulations drive many of the underlying requirements and options available to plan sponsors. Plan sponsors utilize plan documents to define how those specific terms and provisions will apply to their retirement plans. The terms and provisions define who can participate, and how participants will interact with the retirement plan. Participants are also allowed to make certain elections and decisions about their own accounts and contributions, which plan sponsors and recordkeepers must follow.

These data points and provisional items find their way through various recordkeeping systems, payroll systems, human resource information systems (HRIS), trust and custodial accounts, third-party administrators (TPAs), and government reporting systems. The complexity of modern 401(k) plans mean the likelihood that something won’t go as planned is high. Then add on top of that payroll or recordkeeping system changes, employee turnover, a pandemic, vendor changes, and the loss of historical information and knowledge—it is no wonder the IRS created an entire Revenue Procedure and five Fix-it Guides dedicated to correcting common errors in retirement plans.

Let us talk for a moment about that IRS Revenue Procedure – Employee Plans Compliance Resolution System, or EPCRS for short. The EPCRS first published in Rev. Proc 2001-17, is now on its 10th revision in Rev. Proc 2021–30. The EPCRS is a collection of guidance related to specific correction procedures that can provide plan sponsors and their advisors a road map and method under which to correct a variety of issues that arise in qualified retirement plans and avoid plan disqualification.

The EPCRS provides plan sponsors with three avenues for correcting errors in their retirement plans. The Self-Correction Program (SCP), the Voluntary Correction Program (VCP), or the Audit Closing Agreement Program (Audit CAP).

Under SCP, a plan sponsor can correct certain failures without a formal filing and fee to the IRS. For this reason, SCP is the preferred correction method for many sponsors. Specific conditions must be met, and not all corrections are eligible for correction under SCP. For example, plan sponsors must have established formal or informal procedures to use the self-correction program. This is an important feature that is often overlooked when considering SCP. It is not enough that the plan document identifies the issue, sponsors and their administrators should have identifiable practices that they follow that went “bump” and caused the error. Once it is established that some sort of process did not go as planned, SCP is available to correct operational or plan document failures, insignificant failures or significant failures, within three years from the end of the plan year in which the error first occurred.

When we discuss what defines significance, unfortunately that is not as clear-cut as one would hope. However, on www.irs.gov, under SCP FAQs (Frequently Asked Questions), the IRS identifies such factors to include “percentage of plan assets…involved; the number of years the failure occurred; the number of participants affected compared to the total number of participants in the plan; the number of participants affected … compared to the number of participants that could have been affected…” (EPCRS Overview | Internal Revenue Service (irs.gov). Additionally, factors such as other failures in the respective correction period, promptness of correction, and the reason for the error should be considered. Plan sponsors should use their best judgment in determining significance. It is easy to see that an error that occurred affecting 10 people in a plan with 1,000 participants for a period of two payrolls would be considered insignificant, but other situations may not be as clear-cut.

Corrections under SCP should follow the general correction principles of the EPCRS, and in accordance with any specifically documented correction procedures contained therein. Plan sponsors should clearly document the failure, the corrective action, and the changes to procedures to avoid the error occurring again in the future. This documentation should be maintained with other plan information from that period.

When SCP is not an option, when the plan sponsor wishes to obtain formal approval from the IRS, or when the plan sponsor’s proposed correction method is not noted in the EPCRS, the plan sponsor should consider correcting under VCP. VCP requires a submission to the IRS via www.pay.gov. The process for correction is similar to SCP, but the sponsor, or their representative, would complete the required forms identifying the errors, proposing corrections to participants and administrative procedures, and would pay the required user fee. User fees are based on net plan assets reported on the prior year’s Form 5500 and range from $1,500 for a plan with assets up to $500,000, $3,000 for a plan with assets between $500,000 and $10,000,000, and $3,500 for plans with assets over $10,000,000.

In addition to the filing fee, other expenses associated with VCP filings are the consulting fees of the plan advisor or attorney working with the plan sponsor on the correction. Depending on the timespan of the error, correction complexity, and reliability of the data, VCP filings can be expensive and time-consuming.

Once submitted the VCP filing will be assigned to an IRS agent for their review and approval. The IRS agent may ask questions, or require updates or changes to the VCP, before approving or disapproving the corrections. If approved, they will issue a Compliance Statement detailing the errors and correction methods approved by the IRS. The plan sponsor then has 150 days to make the corrections, if not previously completed. At the end of the process the plan sponsor has reliance on the Compliance Statement and the issue is considered closed.

It is important to understand that, once the VCP has been submitted, the plan cannot be audited by the IRS. Thus, it may be in the plan sponsor’s best interest to submit a VCP filing as quickly as possible to avoid additional penalties if the issue is discovered under IRS audit.

Lastly, if the error or failure is discovered while the plan is under IRS audit, the agent may allow the plan sponsor to use SCP for minor issues, request a VCP for slightly larger issues, or engage the plan sponsor to enter into a Closing Agreement with the IRS. The plan sponsor and IRS will negotiate a correction and sanction based on the facts and circumstances of the situation. The sanctions under Audit CAP will not be less than the fee paid under VCP. This is the least desirable outcome, so it’s important to quickly identify and correct under either SCP or VCP as appropriate.

While the IRS EPCRS covers many of the errors that occur in retirement plans, it is important to note that some errors require DOL programs to correct. They include the DOL Delinquent Filer Voluntary Compliance Program (DFVCP) for correcting late or missing Annual Return/Report filing Form 5500, or the DOL Voluntary Fiduciary Correction Program (VFCP) for correcting late deposit of employee contributions and loan payments. These DOL programs will be covered in depth in later articles.

Most failures that occur in 401(k) plans are unintentional and are easily corrected. No plan is perfect, but consistently reviewing operations, making sure that the plan sponsor and its advisors are all on the same page, and that particular care and review is taken whenever changes or turnovers occur in key systems or personnel associated with the retirement plans, will help keep plans as healthy as possible.

Milliman Compliance Consultants and Regulatory Consultants work with plan sponsors routinely to assist in corrections to retirement plans.

Over the course of the next several articles, we will review some standard areas in which 401(k) plans go “bump.” The articles will provide some operational considerations that plan sponsors should use when periodically reviewing the operation of their retirement plans, as well as standard corrections found in the EPCRS, including practical applications to help sponsors better understand the corrections.

We will cover topics from missed deferral opportunities to overpayments, forfeiture, and vesting errors to compensation corrections. Stay tuned—there will be something for everyone.

For more information or assistance with a correction, please contact your Milliman relationship manager or a Milliman Compliance Consultant.

EPCRS Overview | Internal Revenue Service (irs.gov)

Self-Correction Program (SCP) FAQs | Internal Revenue Service (irs.gov)