Significant or Insignificant, That is the Question
Words like “significant” can be really useful when you are trying to convey a subjective concept but you either do not want to or are unable to specifically quantify it. However, those words are not especially useful if you are on the receiving end, trying to determine what someone else means. That is especially true when dealing with legal issues, but it can be an inescapable reality when it comes to correcting mistakes in your 401(k) plan.
The IRS has a program called the Employee Plans Compliance Resolution System, or EPCRS, and it provides guidance on how companies that sponsor retirement plans should correct certain mistakes that can happen. Sometimes, the steps for correction vary based on how significant the mistake is. See, there’s that word…
EPCRS includes two sub programs. The Self-Correction Program (“SCP”) allows plan sponsors to make correction on their own without any formal IRS approval. The Voluntary Correction Program (“VCP”) generally involves more complex errors and requires a formal application for IRS approval.
In order to be eligible to correct an operational error under SCP, the failure must either be fully corrected within two years, or it must be “insignificant.” So, how do we determine whether or not a failure is significant or insignificant? Good question. The IRS has not given us a clear-cut answer, but they have provided a list of the factors they consider when determining significance:
- the number and nature of any other failures that might have occurred during the same time frame;
- the number of years the failure occurred;
- the percentage of plan contributions involved relative to the total contributions made during the period of the failure;
- the percentage of plan assets involved relative to total plan assets;
- the number of participants affected relative to the total number of participants in the plan;
- the number of participants affected affected relative to the number of participants who could have been affected by the failure;
- whether correction was made within a reasonable time after discovery of the failure; and,
- the reason for the failure (for example, data errors such as errors in the transcription of data, the transposition of numbers, or minor arithmetic errors).
EPCRS indicates that no single one of these factors is determinative, so that means we have to look at all of these in totality when doing our analysis. It should also be noted that the factors are not meant to preclude smaller companies from being eligible to use SCP. For example, if a company has only four participants in its 401(k) plan and makes a mistake involving one of them, that is 25% of the total participants. If the company has 100 participants, it only amounts to 1%. As long as all other factors are constant, the failure at the 4-person company is not considered more significant just because the percentage is larger.
The IRS does not give us thresholds for these factors, but they do provide a number of examples that can help make sense of some of these concepts. Here are two of them:
- Percentage of contributions involved: An operational failure involving just over 4% of the total contributions made during the period of the mistake is considered significant.
- Percentage of participants involved: An operational failure involving approximately 6% of the participants is insignificant, while one involving 36% is significant.
The famous photographer Henri Cartier-Bresson once said, “To me, photography is the simultaneous recognition, in a fraction of a second, of the significance of an event.” Like photography, determining whether a plan mistake is significant is part art and part science. Fortunately, we have a little more than a fraction of a second to do the analysis, and making the determination is not quite as illusory as recognizing what makes a good photograph.
If you have discovered a mistake in your plan, give us a call and we will be glad to review the situation with you to help you determine the best way to fix it.
For more information on plan corrections and the significance of a failure, check out this Correction of the Quarter.