“I realize that this is not correct, but how do I fix this error?”
Michael A. Webb, vice president, Cammack Retirement Group, answers:
The Experts agree that you are correct that this is an operational defect. Prior to the issuance of the final 403(b) regulations, it was permissible to exclude collectively bargained employees from the right to make elective deferrals to a 403(b) plan, but the final regulations eliminated that exclusion.
Unfortunately, the fix is not a pleasant one as an employer contribution is required to remedy, which is why it is so important for 403(b) plan sponsors to generally allow all employees to make elective deferrals to the 403(b) plan to satisfy the universal availability requirement for 403(b) plans. The IRS 403(b) Plan Fix-It Guide provides the bad news:
“The amount necessary to correct mistakes involving the failure to allow plan participants to defer salary uses the concept of “lost opportunity cost,” which generally represents the loss of the ability of the salary deferral to grow tax-free in the 403(b) plan. The IRS has determined that this lost opportunity cost is equal to 50% of the amount of the elective salary deferral the employee could have made to the 403(b) plan.
“In accordance with the IRS safe harbor in Revenue Procedure 2013-12 Appendix A.05(6), you may deem the lost salary deferral amount to be the greater of:
• 3% of compensation, or
• the maximum deferral percentage for which the plan sponsor provides a matching contribution rate that is at least as favorable as 100% of the elective deferral made by the employee.
“Therefore, the corrective contribution you need to pay to the plan for the improperly excluded employees would generally be 1.5% of their compensation for each year you excluded them, adjusted for any lost earnings through the date of correction. If you provided matching contributions to the plan for the affected year, you would need to pay additional corrective contributions to the plan to restore matching contributions you would have provided on the missed deferral amounts for the improperly excluded employees.”COMING UP: If you want a separate plan for union employees
Thus, in your case, if there were 100 union employees involved, the corrective employer contribution would be 1.5% of their collective compensation for the entire time period that they were excluded, plus earnings and any related missed matching contribution (more if you have an employer match that is more generous than 100% of 3%). And, of course, you will need to make certain that the affected employees are permitted to contribute going forward, and amend the collective bargaining agreements accordingly.
Finally, you will need to utilize the IRS's correction program known as the Employee Plans Compliance Resolution System (EPCRS) to correct, which may require reporting to the IRS depending on the significance of the defect and other factors.
As an aside, if there is a need/desire not to cover collectively bargained employees in the same plan as nonunion employees, they may be covered in a separate 401(k) or 403(b) plan. As long as all of the collectively bargained employees in question are permitted to make elective deferrals to the separate 401(k)/403(b) plan, and all nonunion employees are permitted to make elective deferrals to the nonunion 403(b) plan, the universal availability requirement for the nonunion 403(b) plan (and the union 403(b) plan, if applicable) will be satisfied.
Thank you for your question!
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