We all know from first grade math that one plus one equals two. However, this basic math concept may not necessarily apply to operational errors discovered under retirement and other plans maintained by an employer. This is because an operational error that is discovered under one plan may also have caused a corresponding unintended error under other plans maintained by the same employer that is greater and more significant than the error discovered under the initial plan. Although just focusing on the plan in which the error was discovered and correcting it is not uncommon, any time an error is discovered in a plan’s operation, it is important to review all plans maintained by the employer to ensure that a corresponding error did not occur in the employer’s other plans.
For instance, if an employer maintains a nonqualified deferred compensation plan that permits eligible employees to defer compensation, the amount of compensation that the employee may have to defer to the employer’s qualified plan may be directly affected by the deferral under the nonqualified deferred compensation plan (assuming the qualified plan definition of “compensation” excludes deferrals to nonqualified plans). Below is an example that highlights this potential compounding effect:
- Assume an employee’s eligible compensation for a pay period was $10,000, and he elected to defer 25% of his compensation to the nonqualified deferred compensation plan, but the employer mistakenly deferred 50% of his compensation.
- If the definitions of “compensation” under both the nonqualified and qualified plans are the same except for the exclusion of nonqualified deferred compensation plan deferrals from the qualified plan compensation definition, the employee should have had eligible compensation of $7,500 for the pay period in which the error occurred under the qualified plan, but in operation only had $5,000.
- If the employee separately elected to defer 10% of his eligible compensation to the qualified plan, he would only defer $500 for the pay period instead of the intended $750. This error would be compounded if the qualified plan provided matching contributions and further compounded if it occurred over multiple pay periods and years and with multiple participants.
If the employer only corrected the error under the nonqualified deferred compensation plan by returning the excess compensation to the affected employee in a manner consistent with IRS Notice 2008-113, the employee’s eligible compensation for the qualified plan for the affected year(s) will not be corrected. As a result, in this example, the employer will also need to determine any impact and corresponding correction to the qualified plan for the employer, as well as any other plans in which the employee participated that calculates a benefit based on compensation that excludes deferrals to the nonqualified plan. Failure to do so may result in serious consequences for the other affected plan (in this case, the qualified plan).
Consequently, whenever an error is discovered under a plan, it is important to not only analyze the scope of the error for the affected plan and correct it, but also to determine whether the correction of such error affects other employer plans that will also need to be corrected. For this reason, one plan error may cause other employer plans to also have an error, so one plus one may equal three (or more) plans with an error.