The Safe Harbor Match That Wasn't
Cascade Logistics adopted a 401(k) plan with a basic safe harbor matching formula: 100% of the first 3% of compensation plus 50% of the next 2%. The plan year is the calendar year. In March, the payroll vendor discovered that, because of a configuration error, the match had been calculated on a per-paycheck basis without the true-up and without regard to the annual compensation limit. Several highly compensated employees received match on compensation above the §401(a)(17) limit. The plan document says the match is computed on annual compensation up to the limit. The employer wants to fix it by depositing a corrective match for the under-matched NHCEs and leaving the over-matched HCEs alone. No one has yet filed anything with the IRS. The plan has 180 employees, 22 of whom are HCEs. The employer asks whether the safe harbor status is preserved and what correction is required.
1. Does the match error destroy safe harbor status for the year?
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Not automatically. A safe harbor 401(k) plan must satisfy the safe harbor contribution requirement, and operational failures can be corrected under EPCRS. The key question is whether the plan operated in a way that is consistent with the safe harbor notice and document. Here the document required an annual true-up and application of the compensation limit, and the plan failed to follow the document. That is an operational failure, not a design failure. Under EPCRS, the employer can self-correct if the failure is insignificant or use the Self-Correction Program (SCP) for significant failures within the correction period. Correcting the NHCE underpayments and recovering or forgoing the improper HCE match on excess compensation is the right direction. However, the employer cannot simply leave the HCE overpayments in place; the excess match attributable to compensation above the limit must be corrected (typically by distributing or forfeiting the impermissible amount, depending on vesting and the correction method).
2. How should the corrective contributions be allocated, and what is the risk of the employer's proposed approach?
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The corrective contribution should put each affected participant in the position they would have been in had the document been followed: calculate the annual match on eligible compensation capped at the §401(a)(17) limit, including the true-up, and deposit the shortfall plus earnings. For NHCEs who were under-matched, the employer deposits the difference with earnings. For HCEs who were over-matched, the excess attributable to compensation above the limit is not a permitted contribution and must be removed. The employer's proposal to fix only the NHCEs and ignore the HCEs leaves the plan in a noncompliant position and creates a nondiscrimination problem because the error disproportionately benefited HCEs. The better approach is a full correction: true up all participants, cap at the limit, and correct the HCE overpayments. Document the methodology and retain it; if the failure is significant and outside the correction period, a VCP submission may be needed.