IRS Issues New Rules for Retirement Plan Corrections

Establishing and operating a tax-qualified retirement plan or a 403(b) plan can be complicated.  Recognizing this, the IRS maintains the Employee Plans Compliance Resolution System (“EPCRS”), which allows employers to correct most errors in plan documentation and operations for qualified retirement plans and 403(b) plans.[1]  Depending on the nature and severity of the error and the circumstances in which it is discovered, the employer may be able to use the Self-Correction Program (“SCP”) to correct the issue without formal IRS involvement, use the Voluntary Correction Program (“VCP”) to pay a specified user fee and file a voluntary application for IRS approval of a correction, or  in connection with an IRS examination obtain IRS approval of a correction in exchange for payment of an IRS-imposed sanction under the Audit Closing Agreement Program (“Audit CAP”). 

SCP generally is the least expensive and easiest program, since it does not involve an IRS application process, but it may not always be the best option.  An employer’s situation may not qualify for SCP, an employer may want the protection of formal IRS approval, or an employer may need IRS approval for a less expensive correction than the correction normally pursued for a given situation under SCP.  VCP, in turn, is designed to be less expensive than Audit CAP, to encourage employers to take proactive action to identify and fix problems before they are identified by the IRS.

The IRS periodically updates the rules for EPCRS corrections, and has now issued its most recently updated rules in Revenue Procedure 2021-30 (  Along with some routine administrative updates and minor revisions, the new Revenue Procedure contains a number of enhancements to the program that are intended to make it more flexible, efficient, and cost-effective.

Most notably, the new Revenue Procedure features the following changes:

Enhanced Access to SCP

Correction under SCP generally is available for “insignificant” operational errors at any time.[2]  “Significant” errors, however, historically have required IRS approval under VCP unless self-correction is completed by the end of the second plan year following the plan year in which the error occurred.  The new Revenue Procedure extends the SCP period for “significant” errors until the end of the third plan year following the plan year in which the error occurred.[3]

In addition, the IRS has expanded employers’ ability to correct certain types of errors by adopting retroactive plan amendments.  Normally, an amendment improving benefits must be adopted by the end of the plan year in which it takes effect, but an employer will now be able to adopt a non-discriminatory, otherwise-permissible amendment that reflects the erroneous addition or improvement of a benefit, right or feature retroactively under SCP.  Previously, SCP had also required that the improved or additional benefit, right, or feature apply to all eligible participants, but that requirement has been dropped in favor of the general rule that the improved or additional benefit, right, or feature be non-discriminatory.  For example, if an employer discovers that it had erroneously accelerated vesting for a group of employees who were terminated in conjunction with a business divestiture two years ago, the employer could retroactively amend the plan to provide for accelerated vesting for the divested group so long as that group did not disproportionately consist of highly compensated employees.  This provision is not a general waiver of the normal deadline for amendments, since employers cannot utilize SCP to correct deliberate plan violations, but it does give employers more flexibility to handle situations in which a plan was inadvertently operated in an overly generous fashion.

SCP retroactive amendments also continue to be available to correct situations in which employees are permitted to commence participation before satisfying age and/or service requirements and/or in advance of an applicable plan entry date, situations in which a plan allows participants to take hardship withdrawals or loans that satisfied statutory requirements but were not permitted under the terms of the plan, and errors in administering the Section 401(a)(17) limit, if the amendment satisfies specified conditions.

Correction of Missed Contributions

When an employee is wrongly prohibited from making elective contributions (pre-tax elective deferrals or Roth contributions) to a 401(k) or 403(b) plan or erroneously has too small an amount deducted and contributed to the plan, the employer must correct the error.  Typically, the IRS requires the employer to contribute from its own assets a percentage of the amount that should have been deducted from the employee’s paycheck, along with the full amount of the match that would have been made, in each case adjusted for lost investment earnings.[4]  The amount that the employer has to contribute to make up for the employee’s missed contributions may be as high as 50% of the amount that should have been deducted from the employee’s paycheck.[5]  However, the amount of this make-up contribution may be as low as 25% or excused altogether, depending on how promptly correction is made and whether certain notice requirements are satisfied. 

In Revenue Procedure 2019-19, the IRS adopted a temporary rule allowing an employer to correct deferral errors related to automatic enrollment or automatic increase errors (including errors in implementing an employee’s choice to file an affirmative election in lieu of contributing at the automatic deferral percentage) by making up only the missed match (adjusted for lost earnings), if (i) contributions commenced in the correct amount no later than the first payment of compensation made on or after the expiration of 9½ months from the end of the plan year in which contributions were first missed[6] and (ii) the employee received a notice explaining the error in accordance with IRS guidelines no later than 45 days after commencement of correct contributions.  This special rule allowed employers to avoid the additional cost of making up a percentage of the employee’s missed deferrals.  The rule expired December 31, 2020, but the IRS has reinstated it retroactively to January 1, 2021.  The rule will now expire for elective deferral failures commencing after December 31, 2023.

In addition, if the employer cannot avoid the need to make up missed elective contributions under the above rule or under the rules allowing correction without make-up contributions for missed-deferral periods not exceeding three months[7] or with respect to employees able to contribute for at least the last nine months of the plan year, the extension of the SCP period for “significant” errors from two years to three years also extends the time period during which an employer can correct a missed deferral error by making a 25% rather than a 50% make-up contribution.[8]  Of course, in all these scenarios, the employer remains obligated to make up any missed matching contributions, adjusted for lost investment earnings.

Finally, on a related but more broadly applicable note, the IRS has revised the provision excusing the making of corrective distributions if the amount due would be $75 or less and the reasonable direct costs of making the payment would exceed the distribution.  This provision applies only to corrective distributions and does not excuse the employer from making corrective contributions, but previously the IRS had indicated that corrective contributions were required if a participant had an account under the plan.  The new language eliminates the reference to an existing plan account, and requires corrective contributions to a “current or former participant, without regard to the amount of the corrective contribution.”  This change will complicate the correction of small amounts involving terminated participants, and if there were a large number of those participants affected by the error, it may be beneficial to consider proposing an alternative approach in a VCP submission.

Correction of Overpayments

Normally, if a plan pays benefits in excess of the proper amount to which a participant or beneficiary is entitled or at a time when a distribution is not permitted, the plan must recoup the overpayment or early payment (adjusted for lost earnings) from the recipient, or the employer or a third-party must reimburse the plan.  The plan must also inform the recipient that the payment was not eligible for rollover. 

Historically, the IRS made an exception to both the recoupment and the rollover-ineligibility requirement for payments of $100 or less.  The IRS has now increased this de minimis threshold to $250, simplifying correction of small overpayments.

Under previous versions of EPCRS, the IRS allowed a defined contribution plan to forego requiring repayment of a benefit that was paid out from a defined contribution plan account prior to the point the payee should have been eligible for payment, but which did not exceed the amount properly in the person’s account.  In contrast, a defined benefit plan has always been expected to seek recovery of an overpayment in excess of the de minimis threshold that is not corrected by a permissible retroactive amendment.  If the plan chooses to seek recovery from the participant or beneficiary, it can do so by reducing future benefit payments (if any) below the properly payable amount using a formula intended to recover the actuarial value of the overpayment,[9] or it can allow the participant or beneficiary to make a lump sum repayment.  If the plan cannot or does not want to obtain repayment of some or all of the overpayment (plus interest typically calculated at the plan’s actuarial rate) from the participant or beneficiary, or if the amount recovered via repayment was less than the amount of the overpayment adjusted for actual lost investment earnings, the employer or a third party normally has to reimburse the plan.[10]

However, the IRS has now authorized defined benefit plans to forego repayment entirely or in part in some circumstances, added some protections for participants and beneficiaries facing repayment obligations, and added the ability for most recipients of an overpayment from a defined benefit plan to enter into an installment payment arrangement to reimburse the plan in lieu of the future-benefit-reduction or lump-sum reimbursement methods, if desired.  

The expanded availability of corrective amendments under SCP will facilitate correction of overpayments via retroactive benefit increase, if the employer is willing to accept the increased liability and the increased benefits will not apply disproportionately to highly compensated employees or violate statutory limits.  A retroactive benefit increase via SCP, VCP, or Audit CAP will legitimize the overpayment and avoid the need to seek reimbursement.  If the employer is not able or willing to retroactively increase benefits, benefits will need to be reduced prospectively to the proper amount.  However, the IRS will allow a defined benefit plan to avoid the need to obtain repayment of an overpayment from a defined benefit plan to a person who is not a “disqualified person” [11] or an “owner-employee” as defined in Section 401(c) of the Internal Revenue Code, if the overpayment was not in excess of statutory limits and one of the following situations applies:

  • Funding Exception Correction Method: If the plan has an Adjusted Funding Target Attainment Percentage (as calculated by the plan’s actuary in accordance with IRS rules) of at least 100%,[12] the employer does not have to repay the amount of the prior overpayments to the plan, nor can recovery be sought from the benefit recipient or that person’s spouse or beneficiary.
  • Contribution Credit Correction Method: The amount of the overpayment that must be recouped or reimbursed will be reduced (but not below zero) based on the impact of the overpayment and its correction on the plan’s minimum funding obligations and certain additional contributions in excess of the minimum funding requirements that were made to the plan after the overpayments began.  In order to use this method, the plan must not have a funding deficiency or an unpaid minimum required contribution as of the end of the last plan year before the plan year for which the corrected benefit payment amount is taken into account for funding purposes.  If the contribution credit reduces the overpayment to zero, the employer does not have to repay the amount of the prior overpayments to the plan, nor can recovery be sought from the benefit recipient or that person’s spouse or beneficiary.  If the contribution credit is less than the overpayment amount, only the net amount needs to be repaid.

If repayment is required, Revenue Procedure 2021-30 establishes the following new rules:

  • A person may be allowed to repay an overpayment via an installment arrangement, so long as that person is not a “disqualified person” under the Internal Revenue Code’s “prohibited transaction” rules[13] or an “owner-employee” under Section 401(c) of the Internal Revenue Code. 
  • While future benefit payments must in any event be reduced to the proper amount, if the employer is using the contribution credit method, the plan must adhere to notice requirements before reducing future benefit payments beyond the properly payable amount in order to recover past overpayments, must allow the participant or beneficiary to opt for a lump sum or (if permissible) installment repayment arrangement over at least five years instead of a reduction in future payments, must calculate the amount to be repaid in accordance with certain standards, and cannot apply a recoupment reduction in excess of specified limitations.
End of Anonymous VCP Submissions

The IRS will no longer accept VCP submissions on an anonymous basis after December 31, 2021.  However, an anonymous pre-VCP conference process will be available (in the IRS’ discretion) for employers that want to obtain feedback on whether a proposed correction is likely to be acceptable before revealing a problem to the IRS.

Next Steps

In order to use EPCRS at all, an employer must have established compliance practices and procedures.  Naturally, proper attention to compliance is also the best way to prevent a problem from occurring in the first place.  Accordingly, staff members who work with a retirement plan need to be familiar with the plan’s terms and understand their legal obligations.  Vendors hired to provide services to a plan must be well-qualified (as well as reasonably priced), and the employer and the plan fiduciaries should work with counsel and other experts (such as accountants and actuaries) who are familiar with employee benefit plans and the special rules applicable to them.  

If a problem is identified, the employer’s staff should take prompt action to remediate the problem and prevent a recurrence.  Correcting plan errors properly requires careful adherence to IRS guidelines.  In addition to the new rules outlined in this newsletter, an employer must comply with a number of general requirements under EPCRS and maintain proper documentation.  Conversely, EPCRS also allows employers to deviate from the IRS’ pre-approved corrections, when doing so is appropriate to the circumstances.  Familiarity with all the IRS’ rules is essential for ensuring that issues are addressed in the way that best meets the plan’s and employer’s needs while satisfying applicable legal requirements.

If you have any questions regarding this LEGALcurrents, please contact any member of the Employee Benefits and Executive Compensation group at 585.232.6500 or 716.853.1616.

[1] EPCRS also offers correction options for SEPs and SIMPLEs.  Additionally, the IRS accepts correction applications relating to missed distributions and certain other issues involving 457(b) plans, applying standards similar to those outlined in EPCRS, although these plans are not covered by EPCRS itself.

[2] The ability to correct plan document problems under SCP is more limited.

[3] Since initiation of an IRS audit generally ends access to SCP corrections for significant errors, prompt action upon discovery of an error remains important.

[4] The purpose of the make-up contribution representing the missed payroll deduction amount is to compensate the employee for lost tax-deferral opportunities (it also serves as an incentive for employers to process deferral properly and correct any inadvertent errors promptly).  A similar rule applies if an employee is denied the opportunity to make after-tax employee contributions or if the full amount of after-tax employee contributions elected by the employee is not deducted from the employee’s paycheck.

[5] If the employee was not permitted to make an election and the plan does not provide for automatic enrollment, the amount of “missed” contributions is determined based on IRS guidelines.

[6] Correct deferrals must begin no later than the earlier of the first payment of compensation made on or after the last day of the 9½-month period that begins when the error first or, if the employer was notified of the failure by the affected eligible employee, the first payment of compensation made on or after the end of the month after the month of notification.

[7] If the employee notifies the employer of the error, contributions in the correct amount must commence no later than the first payment of compensation made on or after the end of the month after the month of notification.  Under either timeline, the employee must receive a notice explaining the error that meets IRS requirements within 45 days of the commencement of correct contributions.

[8] As usual, notification of the error by the employee will accelerate the correction timeframe.

[9] Under this repayment method, “the actuarial present value of the additional reduction, determined as of the date of correction, is equal to the Overpayment plus interest at the interest rate used by the plan as of the date of correction to determine actuarial equivalence.”  A benefit reduction to recover past overpayments cannot apply to a spousal survivor benefit under a joint and survivor annuity, although the survivor benefit must be reduced to the properly payable amount.

[10] The failure to recoup the full amount of the overpayment via the reduction in future payments method, such as due to the death of the participant, does not require additional repayment.

[11] For the most part, “disqualified persons” include plan fiduciaries, plan vendors, plan sponsors, certain owners, affiliates and relatives of disqualified persons, and certain officers, directors, partners, and shareholders. 

[12] For a multiemployer plan, the plan’s most recent annual funding certification must indicate that the plan is not in critical, critical and declining, or endangered status.

[13] Under the “prohibited transaction” rules, a “disqualified person” generally cannot borrow from a plan, although certain exceptions apply for plan loan programs.  Similar rules apply under the Employee Retirement Income Security Act of 1974 (“ERISA”) to a person who is a “party in interest,” which is defined similarly and also includes all employees of the plan sponsor and certain affiliates and service providers.

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