Employee Plans Compliance Unit (EPCU) - Featured Project - 403(b) Universal Availability - Correction Methods |
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Both methods utilize the concept of “lost opportunity cost,” which represents the benefits lost to the employee. Generally, the lost opportunity cost represents the loss of the tax benefit to the employee for having paid income tax on salary that could have been deferred and the loss of the ability of the salary deferral to grow tax-free in the section 403(b) plan. The Service has determined that the lost opportunity cost is equal to approximately fifty percent (50%) of the amount of the salary deferral the employee could have made to the section 403(b) plan.
The first method for calculating the contribution for the excluded employee is based on the average deferral rate of similarly situated employees. The employer determines the “average deferral percentage” (ADP) of the affected employee’s group (i.e., highly or non-highly compensated). Refer to the enclosure for additional information concerning this test. Once the appropriate average deferral percentage is determined for each year affected, each excluded employee is entitled to a fully vested contribution equal to fifty percent (50%) of the employee’s compensation multiplied by the average deferral percentage for that year. If the employer matched the salary deferrals made under the plan, the employee is also entitled to any related matching contribution attributable to salary deferrals. For purposes of determining the amount of salary deferral to be matched, one-hundred percent (100% and not 50%) of the missed salary deferral is used.
Example: Employee A was a nonhighly compensated employee who was incorrectly excluded from participating in a school’s 403(b) plan. The ADP for the nonhighly paid group was 10%. The amount the employer must contribute on the employee’s behalf equals $2,500 (10% multiplied by Employee A’s compensation of $50,000, or $5,000 multiplied by 50%). The Plan also provides for a matching contribution equal to 10% of the salary deferred. The corrective contribution for the matching portion equals an additional contribution of $500 (10% X $5,000). Thus, the total required corrective contribution equals $3,000 ($2,500 + $500) plus an adjustment for earnings. Refer to Revenue Procedure 2008-50 for additional correction information.
The Service recognizes that it is not always possible to make a precise calculation as to what the average deferral percentage would be for a particular year. In that case, reasonable estimates may be used. Even if it is possible to make a precise calculation, where the probable difference between the approximate and the precise calculation is insignificant and the administrative cost of determining the precise calculation would significantly exceed the probable difference, reasonable estimates may be used.
In addition, in lieu of calculating the average deferral percentage, an employer may deem the average deferral percentage to be equal to three percent (3%) of compensation. Under this second method, the employer would make a fully vested contribution for the excluded employee equal to one-and-a half percent (1.5%) multiplied by the employee’s compensation for each year of exclusion. Again, if the employer matched the salary deferrals made under the plan, the employee would be entitled to any related matching contribution attributable to salary deferrals. For purposes of determining the amount of salary deferral to be matched, the average deferral percentage would be considered to be 3%, not 1.5%.
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Page Last Reviewed or Updated: September 02, 2008