“But my plan’s brokerage account investments don’t affect the participants!”

or

“I didn’t have to allocate any profit-sharing dollars, and an audit of my pooled plan would penalize me for my generous selection of excellent investments.”

Unfortunately for the business owner in the above two examples, they wear two hats, one of them being that of a plan participant, with the same protections that apply for a retirement plan governed by the Employee Retirement Income Security Act of 1974 (ERISA), including an audit of the plan’s financial statements. In most cases, a small plan can claim a waiver of the audit requirement, but it depends on:

1. the type of assets the plan holds, including the owners’ participant accounts;
2. whether a regulated financial institution has custody of the plan’s assets;
3. whether the full value of any non-qualifying plan assets is 100% covered by a fidelity bond; and
4. whether additional disclosures about the assets and the fidelity bond are distributed to participants in the Summary Annual Report.

This blog will explain the rules for each of these conditions. As a sneak preview, non-qualifying plan assets often include real estate investment partnerships (REITs), stocks or bonds held outside of an eligible financial institution, hedge funds, digital assets, coin collections, collectibles, statues, sculptures, paintings, other artworks, horses or other animals. We have audited a few small plans that had some of these non-qualifying plan assets.

Whether a fiduciary invests in non-qualifying plan assets for a plan that is not participant-directed or a few participants, even one, invests through their brokerage account, those assets count. It’s often possible to avoid the audit, but not without meeting additional conditions, such as additional bonding, which could prove to be costly enough that the audit is a better option.

Conditions for a Small Plan to Claim an Audit Waiver

A pension plan filing as a small plan because the plan had fewer than 100 participants at the beginning of the plan year, or because the plan administrator elected to use the 80-120 exception, is eligible for an audit waiver if the plan meets the conditions of 29 CFR 2520.104-46.

In addition to being a small pension plan filing the Schedule I, there are three basic requirements for a small pension plan to be eligible for the audit waiver:

1. As of the last day of the preceding plan year, at least 95% of a small pension plan’s assets must be qualifying plan assets (explained below) or, if less than 95% are qualifying plan assets, any person who handles non-qualifying plan assets must be bonded in an amount at least equal to the value of the non-qualifying plan assets.
2. The plan must include additional information in the Summary Annual Report (SAR) furnished to participants and beneficiaries.
3. In response to a request from any participant or beneficiary, the plan administrator must furnish without charge copies of statements the plan receives from the regulated financial institutions holding or issuing the plan’s qualifying plan assets and evidence of any required fidelity bond.
   • The individual account statements from the regulated financial institutions can be delivered by affiliates of the regulated financial institutions, other unaffiliated service providers, or the plan’s administrator.
     • For example, a statement prepared by the regulated financial institution, on the institution’s letterhead including contact information that a participant could use to confirm the accuracy of the information in the statement with the regulated financial institution could be given to the plan’s administrator or its recordkeeper for distribution to the plan participants and beneficiaries.
     • However, a statement prepared by the plan’s administrator, even if based on data from the regulated financial institution, would not meet the audit-waiver condition.

Qualifying Plan Assets Defined

Qualifying plan assets are:

• Any asset held by certain regulated financial institutions;
  • The account must be a trust or custodial account, such as plan assets held in bank custodial, common or collective trust or separate trust accounts are qualifying plan assets.
  • Securities held by a broker-dealer for the plan in an omnibus account are qualifying plan assets.
  • Checking and savings accounts that create a debtor-creditor relationship between the plan and the bank are also qualifying plan assets for the audit waiver condition.
  • Plan assets in a safe deposit box, even with a regulated bank or trust company, are not qualifying plan assets.

• Only the following institutions are “regulated financial institutions” for purposes of the audit waiver conditions:
  • Banks or similar financial institutions, including trust companies, savings and loan associations, domestic building and loan associations, and credit unions.
  • Insurance companies qualified to do business under the laws of a state;
  • Organizations registered as a broker-dealer under the Securities Exchange Act of 1934;
  • Investment companies registered under the Investment Company Act of 1940; or
  • Any other organization the US Treasury department authorized to act as a custodian for individual retirement accounts under Internal Revenue Code section 408.
• Shares issued by an investment company registered under the Investment Company Act of 1940 (for example, mutual fund shares);
• Investment and annuity contracts issued by an insurance company qualified to do business under the laws of a state;
• Qualifying employer securities, as defined in ERISA section 407(d)(5); and
• Participant loans meeting the requirements of ERISA section 408(b)(1), whether or not they have been deemed distributed.
• In the case of an individual account plan, any assets in the individual account of a participant or beneficiary over which the participant or beneficiary has the opportunity to exercise control and with respect to which the participant or beneficiary is furnished, at least annually, a statement from a regulated financial institution describing the plan assets held or issued by the regulated institution and the amount of such assets;

How to Calculate the Percentage of Qualifying Plan Assets

• Obtain the breakdown of the value of plan assets reported on Form 5500, Schedule I, Line 1a, Column (b) for the end of the prior year. The value reported as of the end of the prior year should match the value reported as of the beginning of the current plan year’s Form 5500.

• The calculation must be made as soon as the information regarding the plan’s assets at the close of the preceding plan year can be reasonably ascertained. This generally will be much sooner than the due date for filing the Form 5500 for that preceding plan year, but how is the calculation done for initial plan years, when there is no prior year Form 5500 or when a significant transfer of assets is expected after the first day of the plan year?
• In the initial plan year, the plan administrator may rely on estimates. The administrator should follow a similar method to the one described in 29 CFR 2580.412-15 for estimating the amount required for the ERISA section 412 fidelity bond for an initial plan year.
  • For example, if a plan will be investing exclusively in assets that meet the definition of qualifying plan assets, such as pooled separate accounts, insurance contracts, and mutual fund shares, fidelity bond coverage in addition to that required under section 412 would not be necessary to meet the first condition for claiming the audit waiver.
  • When a plan is initially funded through the transfer of assets from a predecessor plan, treat the new plan as not having a preceding reporting year and use the value of the assets transferred from the predecessor plan to determine whether the new plan meets the 95% percentage condition for qualifying plan assets.
  • Be mindful that some plan assets-whether non-qualifying or even qualifying-might lack a readily determined value. An asset might not trade often enough, or in a market liquid enough, that observing traded prices sets a fair value. Some assets require an appraiser’s valuation.

The ERISA Fidelity Bond Rules

The ERISA section 412 fidelity bond is not the same as fiduciary-liability coverage. Only the ERISA Section 412 fidelity bond is mandatory. The ERISA fidelity bond must meet the requirements of section 412, ( See Field Assistance Bulletin No. 2008-04 or 29 C.F.R. § 2550.412-1 and 29 C.F.R. Part 2580) such as:

• the plan must be named as an insured party;
• the bond must not include a deductible or similar feature;
• plan officials who handle plan assets can be covered by name or by title;
• service providers who handle plan assets by virtue of their duties relating to the receipt, safekeeping, or disbursement of funds, whose duties involve access to plan funds or decision-making authority that can give rise to a risk of loss through fraud or dishonesty should be covered by a fidelity bond.
• the bonding company must be on the U.S. Department of the Treasury’s Circular 570 list of approved surety companies.
• An “omnibus clause” is sometimes used as an alternative way to identify multiple plans as insureds on one bond, rather than specifically naming on the bond each individual plan in a group of plans. The required amount of coverage must apply to each plan separately.
• The plan can pay for the fidelity bond premiums out of plan assets.
• 29 CFR 2580.412-5 states that employee and employer receivable become plan assets once the funds are segregated from the employer’s assets and identified in separate books and records, special bank or investment account, or paid to a corporate trustee. However, if the plan administrator is a board of trustees or entity other than the employer establishing the plan, then receivables are not plan assets until they are received by the plan administrator.
• Commercial Crime Policies often include an ERISA rider compliant with ERISEA Section 412.
• Plans that have at least 95% qualifying plan assets must obtain a fidelity bond covering persons who handle plan funds in an amount no less than 10 percent of the amount of funds the person handles, but in no case shall such bond be less than $1,000 nor does ERISA section 412 require it to be more than $500,000, or $1,000,000 for plans that hold employer stock.
  • Handling of plan assets includes, but is not limited to:
    • physical contact (or power to exercise physical contact or control) with cash, checks or similar property;
    • power to transfer funds or other property from the plan to oneself or to a third party, or to negotiate such property for value (e.g., mortgages, title to land and buildings, or securities);
    • disbursement authority or authority to direct disbursement;
    • authority to sign checks or other negotiable instruments; or
    • supervisory or decision-making responsibility over activities that require bonding.

To satisfy the requirements of the small plan audit waiver, if more than ten percent of the plan’s assets are non-qualifying assets, persons who handle non-qualifying assets must be covered by a fidelity bond or bonds that meet the requirements of section 412 of ERISA, except that the bond amount must be at least equal to 100% of the value the non-qualifying plan assets the person handles.

• If the only non-qualifying assets that a person handles are not required to covered under a standard ERISA section 412 bond, that person would not need to be covered under an enhanced bond for a plan to be eligible for the audit waiver.
  • For example, employer and employee contribution receivables described in 29 CFR 2580.412-5 do not need to be covered by the fidelity bond
• The person handling the non-qualifying plan assets can obtain his or her own bond.
• If 100% of the value of non-qualifying plan assets is less than 10% of the value of all the plan funds a person handles, the section 412 bond covering the person will satisfy the audit waiver condition because the amount of the bond will be at least equal to 100% of the non-qualifying plan assets handled by that individual.
  • For example, a person may handle a total of $1 million in plan funds, but only $50,000 are non-qualifying plan assets. In that case, the ERISA section 412 bond covering the person should be equal to or greater than $100,000, which would be more than the value of the non-qualifying assets the person handles. For that person, the ERISA section 412 bond would also satisfy the audit waiver enhanced bonding requirement.
• The cost of increasing the fidelity bond coverage to cover the value of non-qualifying plan assets could be greater than the cost of the audit.

Summary Annual Report Disclosures

The plan administrator must include the following additional information in the Summary Annual Report (SAR) furnished to participants and beneficiaries to be eligible for the small pension plan audit waiver:

• The name of each regulated financial institution holding or issuing qualifying plan assets and the amount of such assets reported by the institution as of the end of the plan year;
• The name(s) of the surety company issuing the fidelity bond, if the plan has more than five percent of its assets in non-qualifying plan assets;
• A notice indicating that participants and beneficiaries may, upon request and without charge, examine or receive from the plan copies of evidence of the required bond and copies of statements from the regulated financial institutions describing the qualifying plan assets; and
• A disclosure stating that participants and beneficiaries should contact the Department of Labor’s Employee Benefits Security Administration (EBSA) Regional Office if they are unable to examine or obtain copies of the regulated financial institution statements or evidence of the required bond.

The enhanced SAR disclosure is not required for the following qualifying plan assets:

• Qualifying employer securities as defined in section 407(d)(5) of ERISA and the regulations issued thereunder;
• Participant loans meeting ERISA section 408(b)(1) and the regulations issued thereunder; and,
• In the case of an individual account plan, any assets in the individual account of a participant or beneficiary over which the participant or beneficiary has the opportunity to exercise control provided the participant or beneficiary is furnished, at least annually, a statement from an eligible regulated financial institution describing the assets held or issued by the institution and the amount of such assets.

Even if 95% of the plan’s assets are qualifying plan assets, to be eligible for the audit waiver, the SAR must include the required information on the regulated financial institutions holding or issuing the plan’s qualifying plan assets.

Sample SAR Template

The following example may assist administrators in composing SAR disclosures for their plans that would satisfy the regulation. Plan administrators will need to modify the example to omit bonding or other information that is not applicable to their plan.

The U.S. Department of Labor’s regulations require that an independent qualified public accountant audit the plan’s financial statements unless certain conditions are met for the audit requirement to be waived. This plan met the audit waiver conditions for (insert year) and therefore has not had an audit performed. Instead, the following information is provided to assist you in verifying that the assets reported in the Form 5500 were actually held by the plan. At the end of the (insert year) plan year, the plan had (include separate entries for each regulated financial institution holding or issuing qualifying plan assets): [set forth amounts and names of institutions as applicable] [(insert $ amount) in assets held by (insert name of bank)], [(insert $ amount) in securities held by (insert name of registered brokerdealer)], [(insert $ amount) in shares issued by (insert name of registered investment company)], [(insert $ amount) in investment or annuity contract issued by (insert name of insurance company)] The plan receives year-end statements from these regulated financial institutions that confirm the above information. [Insert as applicable –

The remainder of the plan’s assets were (1) qualifying employer securities, (2) loans to participants, (3) held in individual participant accounts with investments directed by participants and beneficiaries and with account statements from regulated financial institutions furnished to the participant or beneficiary at least annually, or (4) other assets covered by a fidelity bond at least equal to the value of the assets and issued by an approved surety company.]

Plan participants and beneficiaries have a right, on request and free of charge, to get copies of the financial institution year-end statements and evidence of the fidelity bond. If you want to examine or get copies of the financial institution year-end statements or evidence of the fidelity bond, please contact [insert mailing address and any other available way to request copies such as e-mail and phone number].

If you are unable to obtain or examine copies of the regulated financial institution statements or evidence of the fidelity bond, you may contact the regional office of the U.S. Department of Labor’s Employee Benefits Security Administration (EBSA) for assistance by calling toll-free 1-866-444-EBSA (3272). A listing of EBSA regional offices and general information regarding the audit waiver conditions applicable to the plan can be found at U.S. Department of Labor under the heading “Frequently Asked Questions”.

How to File the Audit Report for a Small Plan

The plan administrator must disclose that it is claiming the waiver by checking “yes” on Line 4k of Schedule I of the Form 5500 filed for the plan.

Small pension plans that cannot claim the audit waiver still file Schedule I, but must attach the report of an IQPA to their Form 5500. They also do not need to include schedules of assets held for investment, a schedule of reportable transactions, the Schedule C or Schedule G.

Small plan that are growing may not need to file as a large plan the first year that they have at least 100 participants as of the beginning of the year, if they take advantage of the 80-120 exception.

• The 80-120 participant rule gives the plan sponsor the opportunity to elect to file a Form 5500 for the same size of plan as it filed in the previous year, as long as the number of account balances on the first day of the plan year is between 80-120.
• This is not a one-time election. Each year, the plan sponsor must look at the number of account balances on the first day of the plan year and determine whether the 80-120 election can postpone the audit for one more year.
• The 80-120 exception is not available to first year plans because they did not file a Form 5500 in the previous year.
• Initial year filings use the number of account balances at the end of the year to determine whether they need a small plan filing or a large plan filing.
• Plans that are losing employees do not typically use the 80-120 election to choose to continue filing as a large plan.
• Do not count the forfeiture balance for this purpose.
• Do not rely on computerized counts if the plan is close to the large plan threshold
• Please refer to our previous article, “Counting What Counts, Counts the Auditors Out” for more details on the 80-120 Rule.

Only plans filing as small plans can rely on the small pension plan audit waiver.

If ERISA section 103’s command to engage an independent qualified public accountant does not apply, the plan need not meet the audit waiver conditions in 29 CFR 2520.104-46. A plan is not ERISA-governed if it is a governmental plan or is a church plan that has not elected to be ERISA governed. But don’t rely on any exclusion or exception from ERISA until you have carefully considered your employee-benefit lawyer’s advice.

Are There Other Ways to Avoid the Audit?

Owners of employers who sponsor retirement plans, both large and small, sometimes think that ERISA’s job is to protect the benefits and the rights of their employees, which do not and should not include plan assets the owner bought through the plan’s brokerage link. In addition, small pooled profit-sharing plans that do not include participant direction sometimes include investments that could trigger a financial-statement audit if their value is not properly bonded, much to the surprise of the unsuspecting plan administrator. In both instances, the plan sponsor wants to know how to get rid of me for future years, nothing personal. They enjoy our audits as much as anyone can enjoy an audit.

In several cases, I assisted or encouraged each one to collaborate with its third-party administrator and/or recordkeeper to achieve the audit waiver. Some audit-avoidance options I have witnessed in action include:

1. Obtaining the required fidelity bond for the year following the first two years that did not meet the audit waiver requirements.
2. The owner was over 59 1/2 years old, the plan’s age requirement for an in-service distribution. He completed a rollover of the non-qualifying plan assets to an IRA to distribute the non-qualifying plan assets in his account out of the plan.
3. One plan changed the pooled-plan structure to a standard 401(k) platform offered by one of the major recordkeepers, including only qualifying plan assets.

Glad I Did It, Glad It’s Over

I have enjoyed auditing a handful of small plans that failed to meet the waiver requirements. Personally, I don’t like to sell audits that are not absolutely necessary, so I am glad I have audited a handful of small plans, but I’m also glad those engagements are over. It was good while it lasted. I hope they remember me fondly someday when their companies prosper and their plans grow.

       

403(b) plans are bound by a universal availability mandate, whereby if one employee has the opportunity to defer, all employees must have the opportunity to defer. Since 1989, the universal availability mandate could be subject to the following exceptions, which allowed 403(b) plans to exclude:

1. Student employees;
2. Nonresident aliens;
3. Employees who are eligible under another 401(k), 403(b), or governmental 457(b) plan of the same employer;
4. Employees who normally work fewer than 20 hours per week. This last exception, which excludes part-time employees based on hours-worked, is affected by the LTPT Rules of the SECURE Act.

403(b) Plan Eligibility Exclusions After SECURE 2.0

The SECURE 2.0 Act enacted LTPT rules for 403(b) plans effective for plan years beginning after December 31, 2024, (January 1, 2025 for calendar year plans), requiring that employees who work between 500-999 in each of two consecutive eligibility periods be permitted to contribute elective deferrals to the plan, even if they were excluded before 2025 because they typically work fewer than 20 hours per week. It means that the “typically works fewer than 20 hours per week” exclusion only works for two years, if the employee works between 500-999 hours, and they are not covered by one of the other three exclusions.

IRS Notice 2024-73, explains that the LTPT rules do NOT supersede the other three exceptions to the universal availability rule, such that students, nonresident aliens, and employees eligible to other plans can still be excluded from the plan, as long as the exclusions are applied consistently to all employees who still meet each category. See our previous blog post Long-Term, Part-Time (LTPT) Guidance for 403(b) Plans for additional details.

Once-In, Always-In

The Once-In-Always-In (OIAI) Rule dictates that once an employee meets the eligibility requirements of a 403(b) plan, either the LTPT eligibility requirements or the regular ones, the employee will permanently retain the right to make elective deferrals, even if their hours fall below the required 500 hours for LTPT or 1,000 hours for regular eligibility. For interesting background and history behind the Once-In, Always In rules, see our old blog post Are Your Part Time Employees “In or Out” OR “In and Out?”

Employer Contributions Not Required, but Permitted/LTPT Inclusion in the Testing Sometimes Required, Sometimes Permitted

Employer contributions are not required for LTPT employees, including safe harbor and top-heavy contributions, (the top-heavy test does not apply to 403(b) plans), but if the plan sponsor chooses to make employer contributions on behalf of LTPT employees:

• the employer can choose to exclude the LTPT employees when performing the required discrimination testing of the employer contributions, for as long as they are LTPT employees. However, if LTPT employees are excluded from one test, they must be excluded from all tests. Additionally, all LTPT employees must be included or excluded from the testing;
• hours of service performed by LTPT employees on and after Jan. 1, 2023 must be taken into account in determining their vested interest in such employer contributions (500 hours equals one year of vesting);

Former LTPT Employees and Vesting: Nobody Said Life Would Always be Fair

LTPT employees who meet the regular eligibility criteria (typically 1,000 hours) in a later year will never again be an LTPT employee. Their new designation is “Former LTPTs”. Former long-term, part-time employees cannot be excluded from employer contributions or discrimination testing, but they continue to vest in employer contribution at the rate that LTPT employees vest: each 12-month vesting computation period (starting on or after January 1, 2023), in which the employee works at least 500 hours will count as a vesting year of service. Please see our previous blog Long-Term, Part-Time Employee Administration for examples of a vesting computation.

Many industry practitioners find it unfair that Former LTPT employees are credited with a year of vesting after 500 hours, while similarly situated, non-LTPT eligible employees are likely required to work double, 1,000 hours, to achieve the same vesting. Plan sponsors who are bothered by this inequity have the option of amending the plan to require 500 hours in a vesting service period for all eligible participants. Don’t Raise the Bridge, Lower the Water.

When Hours Worked are Not Available

But I pay my part-time employees by the task, or by the day.

For employees who are paid by the day or by the task, employers may not have the number of hours worked. In those cases, the plan document can choose a permitted equivalency method to determine eligibility by crediting:

• 10 hours per day
• 45 hours per week
• 95 hours semi-monthly
• 190 hours per month

Other options, such as 8 hours per day or 40 hours per week are not available. Under each equivalency method, the employee is attributed the entire equivalency, even if only one hour was worked during that day, week, semi-monthly period, or month.

Avoiding the LTPT Rules

Favorable Eligibility Provisions: Any eligibility provision that allows plan entry at or before 500 hours of service avoids the LTPT rules:

• Immediate eligibility
• Two months of service – equivalency method
• Three months of service – equivalency method
• 500 hours of service in twelve months
• The elapsed-time method: maybe

The Elapsed-Time Method

Plan sponsors and practitioners tend to think that choosing the elapsed-time method eliminated the possibility of having LTPT employees, but it is not a guarantee. Using the elapsed time method also avoids the LTPT rules for most employees, since the employee only needs to be employed at the beginning and the end of the eligibility computation period, without regard to hours actually worked, equivalencies, or even periods of absence during a twelve-month period. However, employees who do not meet the elapsed-time method requirements, because they leave and come back more than 12 months later, could still meet the LTPT requirements by working 500-999 hours two years in a row, separated by a 13-month period of absence that straddles the two plan years.

For example:

• 1/1/2023 – Date of Hire (DOH)
• 7/1/2023 – Date of Termination (DOT) after working 501 hours
• Break in Service
• 8/1/2024 – Date of Rehire (DORH)
• 12/31/2024 – 501 hours worked

The above employee would be an LTPT employee in a plan that uses the elapsed time method to determine eligibility.

If you’re thinking that the above situation would almost certainly have been an inadvertent improper exclusion in your case, don’t fret. The IRS’s correction program, the Employee Plan Compliance Resolution System (EPCRS), found in Revenue Procedure 2021-30 has standard pre-approved correction methods for improper exclusions, since they are a common mistake.

Mistakes Happen: Correcting Improper Exclusion of LTPT Employees

If an employee is inadvertently excluded, EPCRS correction procedures generally require that the employer deposit a percentage of the omitted deferrals plus 100% of the missed match, as applicable. Employers cannot ask the employees how much they would have contributed had they been given the opportunity to defer. For 403(b) Plans and 401(k) Safe Harbor Plans, Revenue Procedure 2021-30, Appendix A.5(6) provides a safe-harbor computation for the omitted deferrals to be the greater of:

• 3% of eligible compensation, or
• the maximum deferral percentage for which the employer provides a 100% match contribution (or greater)

The following chart summarizes the corrective contributions required if an LTPT employee is improperly excluded.

How Will the Auditors Test LTPT Administration?

1. The auditor will isolate employees who worked between 500 and 999 hours in plan years beginning in 2023 and 2024.
   1. If eligibility periods switch from the first year of employment anniversary to the plan year, the auditor will take it into account for new employees
2. For a sample of LTPT employees, the auditor will request evidence that the participants were given the opportunity to defer.
   1. Election forms are a best practice, but auditors might be willing to accept any evidence that the employees were informed of their eligibility, including emails, invitations to enrollment meetings, or signed policy manuals.

An Ounce of Prevention is Better than A Pound of Cure

Be prepared. Both small and large 403(b) plan sponsors should perform the steps that the auditors will or would take to ensure that they properly identify LTPT employees. In most cases, LTPT employees will decline to participate when given the choice, but the employer cannot assume what they would do. It’s important to keep records that LTPT employees were given the opportunity to defer when they became eligible. Document, document, document so that you can show off your best practices to your friendly financial statement auditor and if necessary, a government auditor or investigator. An ounce of prevention is better than a pound of cure.

       

Background and Timeline

• December 2019 – The SECURE Act introduced the Long-Term Part Time employee rules.
• September 2020 – IRS Notice 2020-68, included LTPT vesting guidance that later became obsolete.
• January 1,2021- vesting service for LTPT determination started counting for
• January 1, 2024 -initial eligibility for LTPT employees of for-profit entities but on
• December 29, 2022, the SECURE 2.0 Act modified the LTPT rules before they became effective.
• November 27, 2023- Proposed Regulations issued for Long-Term, Part-Time Employee Rules for Cash or Deferred Arrangements Under Section 401(k)
• January 1, 2024- For profit corporation LTPT employees became eligible, except if they were part of an excluded group.
• January 1, 2025- 403(b) plan LTPT employees became eligible. If a participant works between 500 and 999 hours for two consecutive years, the exclusion of participants who work an average of 20 hours or less cannot apply once the participant meets the LTPT rules.

Identifying LTPT Participants: Two Consecutive Eligibility Periods

LTPT participants must be given the opportunity to contribute employee deferrals if they work between 500 and 999 hours for two years in a row, but two years may not mean 24 months if the plan’s eligibility periods switch from the first hire date anniversary to the plan year for subsequent years.

Two years of credit for thirteen months of work: Two eligibility years means thirteen months for a November 1 hire, if the adoption agreement says that the first eligibility period is the hire date anniversary and subsequent eligibility periods follow the plan year:

• First eligibility period: November 1, 2023 – November 1, 2024
• Second eligibility period: January 1, 2024-December 31, 2024
• Entry date: January 1, 2025

See our blog titled How to Get Something for Nothing. As you can see, an employee’s first LTPT year MUST begin with the date of hire and then the employer has a choice to switch to the plan year and if it does, then the second year will overlap the first year, giving the employee double credit for the same months of work.

Service prior to 2021 for SECURE and 2023 for SECURE 2.0 is disregarded for LTPT employee identification, so plan-year hours are used for employees hired before those dates when plans switch the computation period to the plan year.

In my opinion, switching to the plan year sets all the computation periods on the same clock and simplifies administration. Using the hire-date anniversary for eligibility and vesting computations causes additional tracking and additional work.

Hours Worked Not Available? Use the Equivalency Method

For employees who are paid by the day or by the task, employers may not have the number of hours worked. In those cases, the plan document can choose a permitted equivalency method to determine eligibility by crediting:

• 10 hours per day
• 45 hours per week
• 95 hours semi-monthly
• 190 hours per month

Other options, such as 8 hours per day or 40 hours per week are not available. Under each equivalency method, the employee is attributed the entire equivalency, even if only one hour was worked during that day, week, semi-monthly period, or month.

Avoiding the LTPT Rules

Favorable Eligibility Provisions: Any eligibility provision that allows plan entry before 500 hours of service avoids the LTPT rules:

• Immediate eligibility
• Two months of service – equivalency method
• Three months of service – equivalency method
• 500 hours of service in twelve months

Exclusions Other than Age or Service

Employees who work in an excluded division or excluded class of employees (other than because of age or service) are not subject to the LTPT group rules. The substance of the exclusion matters more than the form, such that the exclusion conditions cannot be hourly exclusions in disguise. The Regulations specifically say that employers cannot use exclusions that are a disguise for hours of service, such as excluding “seasonal” or “part-time” employees. To determine whether the excluded class of employees is a proxy for excluding LTPT employees, the IRS will likely analyze what percentage of the people being excluded would have met the LTPT rules and whether some LTPT employees are still being allowed to defer into the plan in spite of the exclusion. For example, if the plan excludes interns, and all the interns would have been LTPT employees, the IRS could determine that the exclusion is a proxy for excluding LTPT employees. Excluding classes of employees that happen to be part-time is a suspicious and risky choice.

Union employees and nonresident aliens can also be excluded but the hours of service while being a union employee or a nonresident alien count if the employee changes classification, just like they would for eligibility to the plan.

The Elapsed Time Method: Using the elapsed time method also avoids the LTPT rules for most employees, since the employee only needs to be employed at the beginning and the end of the eligibility computation period, without regard to hours actually worked, equivalencies, or even periods of absence during a twelve-month period. However, employees who do not meet the elapsed-time method requirements, because they leave and come back more than 12 months later, could still meet the LTPT requirements by working 500-999 hours two years in a row, separated by a 13-month period of absence that straddles the two years.

For example:

• 1/1/2023 – Date of Hire (DOH)
• 7/1/2023 – Date of Termination (DOT) after working 501 hours
• Break in Service
• 8/1/2024 – Date of Rehire (DORH)
• 12/31/2024 – 501 hours worked

The above employee would be an LTPT employee in a plan that uses the elapsed time method to determine eligibility.

Once-In-Always-In

Once an LTPT employee meets the initial LTPT eligibility requirements, the employee remains eligible even if hours-of-service drop below 500 in a subsequent year.

• 2023-500 Hours
• 2024-500 Hours
• Entry date 1/1/2025
• 2025-400 Hours
• 2026-400 Hours

The participant is still eligible to defer in 2025 and 2026.

• 2027-1000 Hours

The Former LTPT becomes a regular participant on 1/1/2028.

Rehires

LTPT Rehires are immediately eligible upon rehire, without having to wait for the next entry date, if they have not incurred five breaks in service.

Former Long-Term, Part-Time Employees

If an LTPT employee later meets the regular eligibility requirement, the employee will never be an LTPT employee again. LTPT employees who later become regular participants are considered Former LTPT participants and are still subject to the LTPT vesting rules:

• 401(k) plans – one year of vesting service for every year since 2021with 500 hours
• 403(b) plans – one year of vesting service for every year since 2023 with 500 hours

The following example demonstrates vesting service credits given to a 401(k)-plan participant who was hired on January 1, 2020:

Employer Contributions

LTPT employees do not have to be eligible to receive employer contributions, including safe harbor contributions and top-heavy contributions. The plan document must indicate that the LTPT employees are excluded from safe harbor contributions. Alternatively, LTPT employees can be eligible for a different employer contribution amount than regular employees.

Discrimination Testing

Even if LTPT employees receive an employer contribution, the plan can exclude LTPT employees, but not Former LTPT employees, from the:

• ADP test
• ACP test
• Coverage test
• 401(a)(4) nondiscrimination test
• Minimum gateway contribution
• Average benefit percentage test

However, if LTPT employees are excluded from one test, they must be excluded from all tests. Additionally, all LTPT employees must be included or excluded from the testing.

Top-Heavy Contributions vs. Top-Heavy Testing

Like safe-harbor contributions, top-heavy contributions for LTPT employees are optional, but the plan document must say whether LTPT employees are excluded from top-heavy contributions.

Regardless of whether the plan excludes LTPT employees from the top-heavy contribution, the LTPT employee accounts MUST be included in the top-heavy test. Including the LTPT employees in the top-heavy test will generally make it easier to pass the top-heavy test, unless the LTPT employee’s account is aggregated with a key employee account for the top heavy test due to family attribution.

Audit Considerations

LTPT Employee balances are not excluded for the determination of the audit requirement. Please refer to our blog titled Counting What Counts, Counts the Auditors Out for the mechanics of the audit requirement.

Automatic enrollment increases the number of balances that are counted to determine if an audit is required. Since automatic enrollment is optional for LTPT employees of plans that are not subject to mandatory automatic enrollment, existing plans that are teetering around 120 balances should consider whether automatic enrollment will trigger an audit requirement. Plans that are subject to mandatory automatic enrollment should automatically enroll LTPT employees. Additionally, the optional inclusion of LTPT employees in the discrimination tests will also affect the decision to automatically enroll participants.

To test whether LTPT were properly given the opportunity to participate, the auditor will identify the population of LTPT employees by:

• Establishing whether the plan’s eligibility computation period changes to the plan year in the second year
• Isolating new employees to compute the hours worked on the first computation period on a sample basis.
• Printing hourly reports for two years for ongoing LTPT determinations
• Requesting election forms for a sample of the identified LTPT employees. Alternatively, eligibility notices, emails, signed policy manuals are acceptable evidence that an opportunity to defer was granted, but they are not a best practice.

Mistakes Happen: Correcting Improper Exclusion of LTPT Employees

If an employee is inadvertently excluded, correction procedures generally require that the employer deposit a percentage of the omitted deferrals plus 100% of the missed match, as applicable. The following chart summarizes the corrective contributions required if an LTPT employee is improperly excluded.

An Ounce of Prevention is Better than a Pound of Cure

Be prepared. Both small and large employers should perform the four steps that the auditors will take to ensure that they properly identify LTPT employees. In most cases, LTPT employees will decline to participate when given the choice, but the employer cannot assume what they would do. It’s important to keep records that LTPT employees were given the opportunity to defer when they became eligible. Document, document, document so that you can show off your best practices to your friendly financial statement auditor and if necessary, a government auditor or investigator. An ounce of prevention is better than a pound of cure.

       

Almost every time I present an educational seminar, at least one attendee asks me if I have a template for a retirement plan audit RFP.

After discussing the importance of selecting a quality plan auditor and providing a list of what should be provided, requested, and the criteria that should be considered, I will provide an RFP outline of the items that make an effective RMD and then a template of an RFP that can be tailored to each plan’s specific needs.

Background

The sponsor of a retirement plan is the Plan Administrator charged with the responsibility of operating the plan in accordance with its terms and with the fiduciary duty of acting in the best interest of the plan participants. The Plan Administrator can delegate many of its administrative and operational responsibilities to another individual or entity, including a pooled plan provider, a third-party administrator, a recordkeeper, and/or an investment advisor, but it always retains the ultimate responsibility for their selection and for their actions. But that’s not all…

When large employee benefit plans require an audit, it is the Plan Administrator’s responsibility to hire an independent qualified public accountant (IQPA). Hiring an auditor is a fiduciary function, such that the Plan Administrator must exercise the same care and prudence in hiring a plan auditor as it does when selecting all the other plan service providers. Similar to other service providers, the Plan Administrator cannot fully delegate the responsibility over the plan’s financial statements to the plan auditor. In fact, the Employee Retirement Income Security Act of 1974 (ERISA) holds Plan Administrators responsible for ensuring that plan financial statements are properly audited in accordance with generally accepted auditing standards (GAAS).

Historically, DOL studies of audit quality have found that over 90% of the nation’s auditors perform less than 25 audits, and those auditors have a deficiency rate above 65%. 6% of the nation’s auditors perform between 25 and 99 audits, and those auditors have a 42% deficiency rate. It means that if your auditor performs less than 100 audits, you have a 50-50 chance that your financial statements include deficiencies. About 750 firms nationwide perform more than 100 audits, and those firms have a 12% deficiency rate. If your audit firm performs 100 audits or more, the odds are in your favor that your audited financial statements do not contain deficiencies.

When a plan auditor is declared deficient by the DOL, the auditor can be sent to the ethics division of the corresponding Board of Accountancy, three years of previously accepted Forms 5500 can be rejected, and the audits have to be redone by a different accounting firm. Belfint, Lyons, & Shuman has performed re-audits when accountants for a takeover client were declared deficient. The DOL assesses penalties to the plan sponsor when the audit is deficient. Hiring a firm that lacks knowledge of the specialized nature of the industry and skills necessary to perform plan audits conflicts with the stated goal of ERISA to protect plan participants.

Are Plan Audits a Priority to the Prospective Audit Firm?

The RFP should ask whether the team performing your audit includes industry specialists, or whether the retirement plan audit is merely an add-on service that is a lower priority for an accounting firm that provides other services to your entity. There are many audit firms that have developed specialized retirement plan audit practices where the plan audit is not a secondary priority to the accounting firm.

The first step towards establishing whether the audit firm is committed to providing quality audits to ERISA plans is to determine whether the firm belongs to the AICPA Employee Benefit Plan Audit Quality Center (EBPAQC). Members of the EBPAQC voluntarily adhere to higher standards of audit quality through their policies, procedures, and training related to the performance of benefit plan audits. The RFP should ask for a list of the industry-specific audit training that each one of the team members assigned to the audit has received.

The Request for Proposal (RFP) Process

An effective RFP will determine the quality of the respondents and will help reduce the time and effort expended in the overall RFP and selection process. In addition, the plan sponsor should provide audit firms with sufficient information about the nature of the plan and the engagement to allow them to make a meaningful and comprehensive proposal that addresses your specific needs and evaluation criteria.

The RFP should include:

1. The name of the plan as it appears on the Form 5500.
2. Details about the Plan such as:

Type of plan

• Plan year end
• Size of plan (number of participants, total assets)
• Name of the auditor’s principal contact with the plan during the RFP process
• Names of the service providers, as applicable: custodian(s), recordkeeper(s), investment advisor, third party administrator, ERISA attorney, actuary, trust arrangements (e.g., master trust investment arrangement)
• Relevant Plan Provisions: the employer contribution formula, eligibility criteria, whether the plan has automatic enrollment, and whether it passes the discrimination test, distribution, loan, and hardship provisions.
• Expected due dates for completion of each service to be rendered.
• The dates when the audit package and payroll report can be available.
• Objectives, expectations, and requirements of the audit engagement to be undertaken.

Scope of the engagement

Describe the services to be provided; the scope of the work and any special considerations, including:

• Number of years that should be covered by the proposal
• First year covered by the proposal
• Whether the audit is a full scope audit or a 103(a)(3)(C) audit (formerly limited scope audit) in accordance with DOL Regulation 29 CFR2520.103-8
• Types of investments held by the plan, whether there are any hard to value investments, and the respective custodians for each investment holding
• Were there any changes in service providers during the year?
• Whether any other services are expected of the CPA firm (such as preparation of Form 5500 or performance of payroll audits)
• Whether the financial statements and auditor’s report will be part of an 11-K filing
• Whether the CPA is expected to attend regular or special meetings with plan trustees, governance committees, or the plan administrator
• Description of any plan changes or significant issues not described above (for example, unique accounting circumstances, consolidations needed, and known areas of difficulty such as hard-to-value investments, discovery of fraud)

Requested Content for the Proposal

The RFP should include questions that address what is important to the plan sponsor, such as:

• The CPA Firm’s size, location, and history
• Whether the firm is a member of the AICPA Employee Benefit Plan Audit Quality Center
• Number of employee benefit plan (EBP) clients
• Number of similar type plan audits
• States in which the firm is licensed to practice
• Firm references — especially from similar type plans — and specific contact information
• Whether the firm has been the subject of any DOL findings or referrals, or any AICPA or State Society Ethics referrals
• Whether the firm has insurance coverage (errors & omissions, workers’ compensation, etc.)
• Information about the audit team that will be assigned to the audit
• Partner in charge of the CPA firm’s employee benefit plan audit practice
• Partner in charge of the audit
• Expected levels of staffing and supervision
• Prior EBP experience and training of the partner in charge and in-charge of the engagement and other key firm personnel pertinent to the engagement
• Details of industry-specific EBP Continuing Education attended by supervisors and above assigned to the team
• Other industry involvement
• Client retention statistics
• Turnover rate for EBP Personnel

Engagement information

• Audit approach
• A detailed fee schedule for each service to be rendered
• Reports to be issued
• Expected completion dates for each portion of the engagement
• Expected level of staff assigned to the engagement
• Biographies for the personnel assigned to the engagement
• Information that is expected to be provided by the plan to the CPA
• Fee structure for any additional services the plan sponsor may request

Proposal Evaluation and Auditor Selection

The following information should be considered during the proposal evaluation and selection process:

• Federal law requires that an auditor engaged for an employee benefit plan audit be licensed or certified as a public accountant by a State regulatory authority. You may wish to verify with the appropriate State regulatory authority that the provider holds a valid, up-to-date license or certificate to perform auditing services.
• Auditors of employee benefit plans should not have any financial interests in the plan or the plan sponsor that would affect their ability to render an objective, unbiased opinion about the financial condition of the plan.
• One of the most common reasons for deficient accountants’ reports is the failure of the auditor to perform tests in areas unique to employee benefit plan audits. The more EBP-specific continuing professional education and experience that an auditor has with employee benefit plan audits, the more familiar the auditor will be with benefit plan practices and operations, as well as the special auditing issues unique to, and rules that apply to such plans.

The technical evaluation should provide a systematic framework for selecting an auditor based on the requirements contained in the RFP. The review of the auditors’ proposals and qualifications should be thorough, uniform, and well documented. Verify that the firm has addressed all items mentioned in your RFP. For those proposals that are complete and have addressed all relevant areas. Consider performing separate evaluations of the proposals based on technical criteria and price. While the price for the work to be performed is a factor in the selection process, the lowest price does not guarantee a quality audit. As mentioned previously, only after the technical evaluation is complete and the qualified respondents have been identified should the plan sponsor review the prices offered by the qualified respondents. Consider whether you want the finalists to present their proposals.

RFP Audit Example Template

The following RFP template contains many of the RFP criteria outlined above. It can be tailored to fit the needs of the plan sponsor conducting an evaluation of audit candidates. As always, we hope you find the tool useful in your quest for a new auditor that fits your needs.

       

This blog was updated 12.19.2025 with enhanced examples. 

Background

Effective January 1, 2026, catch-up eligible participants who are High Earners must make catch-up contributions on the Roth basis. The industry has been using the term Highly Paid Individuals, so we will use both terms for the sake of clarity and consistency with other published articles. Before delving into the details on how to administer this new Roth mandate, let’s review the compensation thresholds that make a participant a High Earner and a contribution a catch-up contribution.

IRS Publishes New Limits

The IRS published the limits applicable to retirement plans in 2026 on Notice 2025-67, as published in our previous blog From the Diamond to the Desk: 2026 Retirement Plan Limits Step Up to the Plate. 2026 contribution limit changes that affect the administration of the Roth catch-up mandate include the 402(g) deferral limit increase to $24,500 and the catch-up limit increase to $8,000. Catch-up eligible participants can contribute a maximum of $24,500 + $8,000 = $32,500 or if they turn ages 60-63 during the plan year, a maximum of $24,500 + $11,250 = $35,750.

High Earner/Highly Paid Individual Limits

The threshold for determining who is a High Earner, or Highly Paid Individual, for purposes of the Roth Catch-up Mandate that will be effective on January 1, 2026 also increased. Specifically, catch-up eligible High Earners who show more than $150,000 in FICA wages on their 2025 Form W-2 must contribute 2026 catch-up contributions of $8,000 or 2026 super catch-up contributions of $11,250 on the Roth basis.

Affirmative Election vs. Deemed Election

Affirmative Elections

Employers and recordkeepers or third party administrators should collaborate to provide participants with deferral election forms that match what the payroll software can process. The types of deferral elections typically offered by payroll companies include:

1. A tentative election: Catch-up contributions are withheld from the beginning of the year, in anticipation of the participant’s total contributions exceeding the 402(g) limit ($24,500 in 2026) or other relevant plan limits.
   • If the participant terminates employment or otherwise does not meet the legislative threshold that triggers a catch-up, the misclassified catch-up money is recharacterized as a regular contribution. The contribution can keep the original source (pre-tax or Roth), such that only the catch-up classification needs to be removed.
   • Plan sponsors must understand that the tentative election method is a practical approach. By definition, catch-up contributions cannot exist before a limit is reached, as applicable:  the 402(g) limit, the plan limit, or the ADP test limit.
     •  If contributions originally designated as catch-ups are not recharacterized as regular contributions for a participant who leaves mid-year, the census information used for the ADP test could be inaccurate. The ADP test is not affected by contribution sources, so the Roth and pre-tax code of the original remittance remains the same, only the catch-up designation needs to be removed.
     •  If the plan does not match catch-up contributions, an employee who leaves mid-year is owed match contributions for the catch-up amounts that must be recharacterized.
2. A spill election: Participants make an election in the form of percentages or dollars and contributions are designated as regular contributions until the 402(g) limit or the plan limit is achieved, and then they are designated as catch-up contributions.
3. A separate election specifically for catch-up contributions that kicks in when the 402(g) limit or the plan limit, if lower, is achieved.

Deemed Elections

If the affirmative election is not compliant, or the participant was automatically enrolled and there is no affirmative election, the final regulations allow plan sponsors to “deem” (i.e., automatically convert) a high-paid participant’s pre-tax catch-up election to Roth, without such participant’s consent and regardless of whether the plan uses a separate, tentative, or spill election.

If the participant’s affirmative election is compliant with the Roth catch-up mandate, implementing a deemed election is not necessary for that person.

Deemed elections are especially useful when participant elections only choose deferrals of a percentage of each payroll or dollar amount per payroll up to $32,500 or $35,725, but the chosen contributions do not include enough Roth dollars to comply with the Roth catch-up mandate. To facilitate the administration of the Roth mandate, the Regulations permit plan sponsors to use two Deemed Election Methods to automatically switch participant contributions to the Roth basis either under:

• Method 1: Once the participant’s total deferrals, including pre-tax and Roth contributions, get to the 402(g) limit, which is $24,500 for 2026, or
• Method 2: Switch the deferrals to Roth once the pre-tax contributions get to the 402(g) limit. Method 2 allows all Roth contributions made during the year to count towards the Roth catch-up mandate.

Depending on the plan sponsor’s demographics, the burden of requesting affirmative elections from all catch-up eligible participants could exceed the burden of sending a deemed election notice, but every plan sponsor must make its own decision based on their participant demographics, the capabilities of their payroll providers, the expertise of their plan personnel, and what works for their company.

Our previous blog, Catch the Catch-Up Final Regulations Before They Catch You Off-Guard explains all the complexities of administering the Roth catch-up mandate in accordance with the Final Regulations. Please refer to that blog for a full discussion of the rules.

In response to requests from our audit clients, this blog will provide examples of the Deemed Elections Methods 1 and 2, for participants contributing to Roth and pre-tax sources throughout the year, as well as for participants contributing only pre-tax, or only Roth contributions.

Example 1: Comparison of Methods 1 and 2

The following example demonstrates Deemed Election Methods 1 and 2 side by side for a participant who contributes $500 Roth dollars and $5,000 pre-tax dollars from each monthly paycheck, a non-compliant affirmative election:

Method 1 disregards Roth deferral contributions made before achieving the 402(g) limit ($24,500 for 2026). Once the participant’s total employee contributions equal the 401(a)(30) limit, which is the employer-based individual 402(g) limit, or $24,500 for 2026, the plan sponsor switches all employee contributions to the Roth basis. Please note that Method 1 prevents this participant from contributing the full 2026 402(g) limit of $24,500 on a pre-tax basis, while also forcing the participant to contribute more than $8,000 in taxable Roth contributions. On the other hand, Method 2 allows a Roth-catch-up eligible participant who wants to maximize pre-tax deferrals to do so, by giving the person credit for Roth deferrals made since the beginning of the year.

If the Roth catch-up eligible participant had made a compliant affirmative election requesting minimum Roth contributions of $666.67 per month or $937.50 for a super-catchup eligible participant, then there would be no reason for the plan sponsor to use either one of the Deemed Election Methods, since the participant will comply with the mandate using the affirmative election submitted.

Example 2: Method 1 Should Not Have Been Used

The following example illustrates an operational error involving an employer that uses Deemed Election Method 1 to increase a participant’s Roth contributions beyond the required $8,000 when the participant’s affirmative election would have resulted in compliant contributions:

Deemed Election Method 1 increased the participant’s tax liability unnecessarily by preventing the participant from contributing the 2026 maximum limit of $24,500 on a pre-tax basis, when the participant’s affirmative election would have resulted in compliant contributions that should not trigger Methods 1 or 2, as shown in the following chart:

Example 3: Method 1 Not Needed, Method 2 Not Triggered

Example 4: No Difference Between Methods 1 and 2

Participants who have made an election to contribute the maximum 402(g) limit plus catch-up completely in pre-tax dollars or completely in Roth dollars would be treated the same under Method 1 or Method 2. If the participant does not wish to make Roth catch-up contributions, the participant would make an affirmative election to opt-out of a catch-up contribution. The deemed-election methodology is presented below, assuming the participant does not opt out of the catch-up contribution:

The deemed election method makes a choice to comply with the Roth catch-up mandate on behalf of the participant, subject to the distribution of a notice, rather than requiring affirmative elections from every participant. Plan sponsors who plan to use the deemed election methods should contact their third-party administrators and recordkeepers before year-end to ensure that the proper notices are distributed.

Assume Nothing

Plan sponsors should collaborate with their payroll providers to understand their responsibilities with respect to the identification of Roth Catch-up Eligible Participants and to switching contributions to Roth when a deemed election method is needed. Plan sponsors may be responsible for coding contributions as Roth contributions on the payroll once the threshold is achieved under Method 1 or Method 2. The process may not be automatic. Assuming that service providers will take care of administering the Roth catch-up mandate will almost certainly land employers in correction-land. Please refer to our previous blog Catch the Catch-Up Final Regulations Before They Catch You Off-Guard for a discussion of the available corrections.

An Ounce of Prevention is Better than a Pound of Cure

Preventing errors by preparing for the accurate implementation of the Roth Catch-up Mandate by taking the following steps will be an investment that plan sponsors won’t regret:

• Before each year ends, run a report to identify most Roth Catch-up Eligible Participants. Verify participants who were on the fence on the first week of January.
• Ensure that Roth Catch-Up Eligible participants are accurately coded in the payroll.
• Understand who is responsible for switching contributions to Roth under the Deemed Election Methods.
• At year end, run a payroll report in Excel and isolate the Roth Catch-up Eligible Participants. The outliars will be easy to spot.
• Determine if a correction is necessary before you issue W-2s. There is no pre-approved correction involving amended W-2s  for Roth Catch-up Mandate corrections at this time.
• Instruct the recordkeeper to move funds from the pre-tax to the Roth source, without issuing a Form 1099-R, for participants for whom you changed the W-2  to reflect the correct deposits.
• If W-2s have already been issued, instruct the recordkeeper to complete an in-plan Roth rollover for the correction amount needed.
• Errors up to $250 do not need to be corrected.

When the Idea is Easier than its Execution…

The Roth Catch-up Mandate is easier to understand than to implement. Without a doubt, the idea is easier than its execution, so it is imperative for plan sponsors to be pro-active in collaborating with the service providers to understand who is responsible for doing what. If all else fails, there is a correction for that, but proper planning will yield a much better outcome…..That was easy!….and aren’t we all about improving retirement-related outcomes?

       

• Applicability and Exemptions: Effective for plan years after December 31, 2024, new plans established after December 29, 2022, must implement automatic enrollment; however, exemptions apply to “grandfathered” pre-enactment plans, businesses with 10 or fewer employees, companies in business for less than three years, and governmental, church, or SIMPLE plans.

• Contribution and Escalation Mechanics: Plans must automatically enroll eligible employees at a uniform default rate of at least 3% (invested in a QDIA), with a mandatory annual increase of 1% up to a cap of 10% (optionally 15%), though participants retain the right to opt out, change their rate, or request a refund of deferrals within 90 days of the first contribution.

• Correction and Merger Rules: The regulations provide specific guidance for preserving grandfathered status during plan mergers—such as a non-grandfathered plan merging into a surviving grandfathered plan—and offer correction methods for enrollment failures that may waive Qualified Nonelective Contributions (QNECs) if the error is fixed within 9.5 months of the plan year-end.

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Blog Updated 12.1.2025 to add technical clarifications that will matter to practitioners.

Mandatory Automatic Enrollment Background

SECURE 2.0 mandates plans established after December 29, 2022 to implement a Mandatory Automatic Enrollment (MAE) provision effective for plan years after December 31, 2024 if:

• The plan sponsor has been in business for at least three years and employs more than 10 people in the preceding calendar year.
• Plan sponsors that hire their 11th permanent employee have until the year following the close of the year after the company or nonprofit employs more than ten people. For example, if the employer hires the 11th permanent employee in June of 2025, it has until January 1, 2027 to establish mandatory automatic enrollment.
• An employer is deemed to have 11 employees if there are at least 11 people on the payroll for half of the preceding year.
• If a business did not previously maintain a retirement plan, the MAE rule applies in the plan year starting after the 1-year anniversary of the first plan year. This gives businesses without a retirement plan for 12 months prior to hiring the 11th employee an extra transition year.
• To count the employees:
  • a full time employee (8 hours per day/40 hours per week or more) counts as one employee
  • part-time employees count as fractional employees
  • common law employees count, even if they are excluded from the plan
  • sole proprietors, partners in a partnership, directors of a corporation, independent contractors do not count
  • leased employees (IRC §414(n)) count toward the employee threshold, even if excluded from the plan
  • collectiely-bargained employees are exempt from mandatory enrollment requirements until the collectively bargained agreement expires
• Church plans, governmental plans, SIMPLE plans, businesses with 10 or fewer employees and businesses that are less than three years old are not subject to the mandate. Also, deferral plans signed prior to mandatory automatic enrollment effective December 29, 2022 are grandfathered and not subject to the rules. These grandfathered plans are called pre-enactment plans.

Other Requirements of Mandatory Automatic Enrollment

• Who Can and Who Must Be Auto Enrolled?: All eligible employees must be covered by automatic enrollment, but participants who had an affirmative election to defer, or not to defer, do not have to be automatically enrolled, although they can be. Also, participants with an affirmative election greater than the automatic enrollment default rate can be excluded from an automatic re-enrollment when the provision is implemented.
• Rehires: Previous employees who have left the entity for a full plan year or more can be treated like a new employee upon their return and automatically enrolled at the initial deferral rate, regardless of previous automatic increases the employee may have received. The plan can also re-enroll the re-hired employee at the deferral rate that was effective prior to the termination, subject to the break-in-service rules.
• Default Deferrals: MAE plans must apply a uniform rate to all eligible participants starting at a 3% default rate.
• Automatic Increases: The Mandatory Automatic Enrollment Regulations of SECURE 2.0 require automatic increases of 1% per year up to 10% with an option to continue the automatic increases up to 15%.
  • Initial Period: The initial period subject to the default automatic enrollment rate can end on the last day of the plan year following the later of the date the participant enters the plan or the date that mandatory automatic enrollment applies to the plan or the participant, or it can end at the end of the plan year when the participant was automatically enrolled.
• Affirmative Election: The participant must be able to make a deferral election different than the automatic enrollment default or make an election not to defer at all.
• Permissible Withdrawals: Up to 90 days after the payroll containing the first deferral, MAE plans must allow automatically enrolled participants to elect to stop their deferrals and have the automatic deferrals refunded. Any match contributions would be forfeited and used in accordance with the plan provisions. Refunded deferrals pay tax, but no penalties, in the year of distribution, and they are not included in the ADP/ACP tests or the 402(g) limits.
• QDIA: MAE plan default deferrals must be invested in a Qualified Default Investment Alternative (QDIA) that complies with the Department of Labor regulations, but participants can change the investment elections once the funds are in the account.
• Notice Requirements: The plan administrator must notify newly eligible individuals at least 30 days but no more than 90 days in advance of their automatic enrollment entry date, so that they have enough time to opt-out. If the participant can also withdraw within a specific amount of time after deferrals start, (usually up to 90 days), the notice must also include that information. Once automatically enrolled, participants must receive an annual notice informing them of all automatic enrollment provisions, including any scheduled automatic increases. The EACA and QACA rules give a safe harbor for notice distribution consisting of 30-90 days before the beginning of each plan year. In the case of newly eligible employees, no more than 90 days before eligibility and no later than the date of eligibility. The Notice can be combined with the QDIA Notice and other annual notices.
• Failures to Automatically Enroll: If a plan sponsor fails to automatically enroll a participant, but deferrals start by nine and a half months after the plan year-end, the plan sponsor does not have to contribute a QNEC for the failed deferral opportunity of the participant, but they must contribute 100% of the match applicable to the default enrollment rate, plus earnings. A notice must be provided to affected participants within 45 days of starting the correct deferrals.

Plan Mergers and Spin-Offs and Mandatory Automatic Enrollment

• If both merging plans were established before December 29, 2022, they are not subject to mandatory automatic enrollment.
• Plans that spin-off from a grandfathered plan are treated as pre-enactment plans, not subject to mandatory automatic enrollment.
• If a non-grandfathered plan and a grandfathered plan merge to form a new plan, the new plan is subject to mandatory enrollment.
• If a non-grandfathered plan merges into a grandfathered plan that becomes the surviving plan, then the surviving plan is still grandfathered

MEPs and PEPs

• The date when the MEP or the PEP was adopted is not relevant.
• One MEP or PEP can have grandfathered plans and plans subject to mandatory automatic enrollment, because the status sticks to the plan, not the MEP or the PEP.
• A merger of two MEPs or two PEPs does not impact the status of the member plans.
• Grandfathered plans that spin off from a MEP still retain their grandfathered status.
• The terms of the MEP or PEP could require automatic enrollment.
• Grandfathered plans that leave a MEP that required automatic enrollment can remove the requirement.

Although many plans subject to the automatic enrollment mandate are not likely to need an audit right away, because brand new plans tend to cover fewer than 100 employees, the automatic enrollment provisions that they must adopt follow very similar rules as those applicable to grandfathered large plans subject to an audit. To provide an efficient way to contrast and compare the available options, and the mandate, please refer to the chart below:

Behavioral Finance

Automatic enrollment has been proven to increase participation rates amongst employees who might have opted to delay or neglect saving for their retirement. Win. Statistically, employees are not likely to take the initiative to opt out, such that employers with automatic enrollment should budget to make the match assuming a high level of participation. Although the cost to the employer may feel burdensome initially, having employees who are retirement-ready may alleviate other costs later in the employment cycle, such as health-care costs. Win. The audit requirement is determined based on the number of account balances at the beginning of each year, so mandatory automatic enrollment may result in a greater number of audited plans. Wink. Recordkeepers, custodians, and investment advisors’ fees often do better as the plans do better. Win, win, win. For all these reasons, automatic enrollment is perceived as the right thing to do for all parties involved. Everybody wins.

       

With the same teamwork, attention to detail, and post-game debriefing we apply after our softball win, now’s the time to gather your retirement-plan playbook, update those thresholds, and make sure everyone on the team knows the new limits. Because in both softball and retirement-planning, small adjustments this season set up big wins down the line.

      

Related Stories

• Long-Term, Part-Time Employee Administration
• Roth Catch-up Mandate Compliance and Deemed Election Examples
• Catch the Catch-Up Final Regulations Before They Catch You Off-Guard

 

• Mandatory Roth Contributions for High Earners: Effective January 1, 2026, “High Earners” (defined as participants with prior-year FICA wages exceeding $150,000) are required to make all catch-up contributions—including the new “Super Catch-Up” for participants aged 60–63—on a Roth (after-tax) basis.

• Exclusions and Plan Limitations: The mandate strictly applies to employees with W-2 FICA wages, meaning self-employed partners and sole proprietors are exempt; furthermore, if a retirement plan does not offer a Roth feature, High Earners are effectively prohibited from making any catch-up contributions at all.

• Compliance and Correction Methods: Plan sponsors may utilize “deemed elections” to automatically switch contributions to Roth once limits are reached, and any inadvertent pre-tax errors can be corrected via specific W-2 correction methods or In-Plan Roth Rollovers.

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*This blog was updated on 11.20.2025 to reflect the new IRS limits applicable to retirement plans for 2026.

The New Mandatory Roth Catch-Up Rules

Section 603 of the Setting Every Community Up for Retirement Enhancement Act 2.0 (SECURE Act 2.0) added Internal Revenue Code (IRC) Section 404(v)(7) to require catch-up eligible High Earners to make catch-up contributions to their 401(k), 403(b), and 457(b) plans on a Roth basis, effective January 1, 2026. However, the Final Regulations corroborate that ANY Roth contributions made by a participant throughout the year can satisfy the Roth catch-up mandate amount of $8,000*, at the election of the Employer.

The Final Regulations issued in September of 2025 are effective as of January 1, 2027, but the Roth catch-up mandate continues to be effective as of January 1, 2026, such that good faith compliance with the rules is expected between January 1, 2026 and December 31, 2026.

High Earners Defined

IRC Section 414(v)(7)(A) specifies that mandatory Roth catch-up contributions apply to catch-up eligible participants whose FICA wages for the preceding calendar year from the employer sponsoring the plan exceeded the applicable limit, as indexed. In this blog, we have identified the affected plan participants as High Earners. Others in the industry call them Highly Paid Individuals (HPIs). Their title is not as important as understanding that they are not the same group of people as the Highly Compensated Employees (HCEs), as explained later in this article.

The 2026 High Earners will be identified using FICA wages as defined in IRC section 3121(a), which are reported on Box 3 of the 2025 Form W-2. If a plan participant’s 2025 FICA wages are greater than $150,000, 2026 catch-up contributions must be made on the Roth basis. Alternatively, at the employer’s election, any Roth contributions made during the year can be included to determine whether the $8,000* mandate has been satisfied.

The Final Regulations clarify that if a participant’s W-2 is later amended and the participant is no longer a High Earner, the deemed Roth election does not need to be revoked.

Participants who do not receive FICA wages, such as partners who only have self-employment income reported on a Form K-1, or sole proprietors who file a Schedule C are not subject to the Roth catch-up mandate.

Super Catch-Up for Participants age 60, 61, 62, 63

For taxable years beginning after December 31, 2024, section 109 of the SECURE 2.0 Act amended IRC section 414(v)(2) to increase the applicable dollar catch-up limit for participants who attain age 60, 61, 62, or 63 during the taxable year (the Super Catch-Up). The increased applicable dollar catch-up limit for 401(k), 403(b), and 457(b) governmental plans is 150 percent of the current catch-up limit. Using the 2025 catch-up limit of $8,000*, the Super Catch-Up amount available to participants who attain ages 60 to 63 during a plan year amounts to $11,250 for 2025 and 2026.

The higher limit (super catch-up) for participants attaining age 60 through 63 during a plan year is an optional plan provision. However, every plan within the same controlled group must make it available to eligible participants, except union members and nonresident aliens can be excluded. Amendments to add the super catch-up are part of the SECURE amendments due December 31, 2026.

Participants who attain ages 60 to 63 during a plan year are subject to the Roth Catch-Up Mandate for their $11,250 super catch-up contributions.

403(b) Special Catch-up and Governmental 457(b) Plan Special Catchup

For details on the mechanics of the 403(b) Special Catch-up and the 457(b) Special Catch-Up, please refer to our previous blogs: How to Compute the 15-Year Special Catch-Up for 403(b) Plans and Special Section 457(b) Catchup for Government Plans

The 403(b) Special Catch-Up optional opportunity for employees with at least 15 years of service is not subject to the Roth catch-up mandate for High Earners. In fact, contributions in excess of the 402(g) limit are attributed to the 403(b) Special Catch-Up first, and then to the 414(v) catch-up, including the increased limit for participants turning 60,61,62, or 63. The Final Regulations specifically state that:

“§ 1.403(b)-4(c)(3)(iv) provides that any catch-up amount contributed by an employee who is eligible for both types of catch-up contributions is treated first as a special section 403(b) catch-up contribution and then as a catch-up contribution under section 414(v). Accordingly, the special section 403(b) catch-up contributions are not subject to section 414(v), including the requirement under section 414(v)(7) that certain catch-up contributions be designated Roth contributions.”

A consistent application of the above concept would lead us to conclude that the special catch-up under IRC section 457(b)(3) permitted for the last three taxable years ending before an individual attains normal retirement age would also not be subject to the Roth catch-up mandate for High Earners.

If the plan does not offer a Roth feature, High Earners are precluded from making catch-up contributions, but other catch-up eligible participants can make catch-up contributions. The Regulations reiterate that in a plan that does not have a Roth feature, the maximum catch-up with respect to the High Earners is zero. The High Earners in this case are treated as if they were not catch-up-eligible.

Highly Compensated Employees (HCEs) are not the same as High Earners

Highly Compensated Employees (HCEs) are not the same as High Earners and are not the same as Key Employees.

1. The High Earner Determination is used for the Roth Catch-up Mandate
2. The HCE determination is used for the ADP discrimination test.
3. The Key Employee determination is used for the Top-Heavy Test, which is beyond the scope of this article.

Highly Compensated Employees Defined: For the 2025 plan year, an employee who earns more than $155,000 in 2024 is an HCE. For the 2026 plan year, an employee who earns more than $160,000 in 2025 is an HCE.

If stated in the document, employers may limit HCE’s based upon compensation to the top 20% of the highest paid employees. This provision does not remove any owners from the HCE determination. Specifically:

1. An employee is considered to be an HCE if he or she owns more than 5% of the company sponsoring the plan at any time during the current or previous plan year, regardless of compensation.
2. Ownership is determined at any time during the current or prior year. Therefore, even if an HCE reduces their ownership below the 5% threshold, they continue to be considered an HCEs through the end of the following plan year.

Using the applicable W-2 wages to identify High Earners and HCEs reveals that High Earners (FICA wages $150,000* in 2025 for 2026 High Earner determination) are not necessarily HCEs ($160,000 in 2025 for 2026 HCE determination), but all HCEs identified by virtue of their wages are High Earners. However, some HCEs do not have FICA wages, so they can never be High Earners.

Self-employed individuals do not have FICA wages and do not get a W-2, so they will never be High Earners, even if their compensation exceeds $150,000*. Counterintuitively, partners in a partnership that only shows self-employment income on their Form K-1, self-employed individuals who file a Schedule C with their Form 1040, and certain government employees are not subject to the Roth catch-up mandate, unlike their employees who likely make less money than they do, but still enough to be High Earners.

To boot, plans that do not offer a Roth feature would effectively prevent High Earners from making a catch-up contribution, while their self-employed bosses enjoy the higher limits on a pre-tax basis. Plans that do not offer a Roth feature could consider excluding self-employed individuals who make more than $150,000* from the catch-up feature to be sure that there is no benefits, rights and features violation. The exclusion would treat High Earners and self-employed participants who make more than $150,000* equally, in a plan that does not offer a Roth feature.

Conversely, the Final Regulations state that there is no benefits, rights, and features violation when all participants in a plan that does not offer a Roth feature receive a W-2, and NHCE High Earners are prevented from making pre-tax catch-up contributions, while their catch-up eligible NHCE colleagues who are not High Earners can make pre-tax catch-up contributions. If everyone gets a W-2 and the plan does not offer a Roth feature, the maximum catch-up available to the High Earners is zero, as if they were not catch-up eligible, and there is no benefits, rights, or features violation.

Employer Sponsoring the Plan Defined

The final regulations provide that the term “employer sponsoring the plan” can refer to the specific common law employer for which the participant works, or in cases where the common law employer is a member of a controlled group that uses a common paymaster, the plan may provide that the employee’s common law employer is aggregated with one or more other specified employers in that group of employers to treat the aggregated employers as a single employer sponsoring the plan for purposes of determining who is a High Earner. In that case, the employee’s FICA wages from the common law employer and from the one or more other employers that are aggregated with the common law employer are treated as FICA wages from the employer sponsoring the plan. Aggregation of wages in situations involving controlled groups and common paymasters is optional.

As we explained previously, FICA wages on Box 3 of a participant’s W-2 determine whether a participant is a High Earner subject to the Roth Catch-up mandate. This applies even in cases of an asset purchase where the successor employer files a Form W-2 for the calendar year of the asset purchase. As a result, a plan that is sponsored by the successor employer (or an entity that is aggregated with the successor employer in accordance with final regulation § 1.414(v)-2(b)(4)(ii) or (iii)) may provide that all of the wages reported in Box 3 of the Form W-2 are treated as wages from the employer sponsoring the plan for purposes of determining applicability of the Roth catch-up requirement.

In the case of multiemployer plans, multiple employer plans (MEPs), and pooled employer plans (PEPs), a catch-up eligible participant’s FICA wages for the preceding calendar year from one participating employer are not aggregated with the participant’s FICA wages for the preceding calendar year from another participating employer in the plan for purposes of determining whether the participant’s FICA wages for that year exceeded the Roth catch-up wage threshold. In the context of the Roth catch-up requirement for multiemployer plans, the signatory employer is the common law employer that is the source of the participant’s FICA wages and contributions to the multiemployer plan (but the plan may provide for aggregation of FICA wages from certain related employers as described earlier in this section).

All Employers in a Controlled Group must permit catch-up contributions and/or super catch-up contributions. High Earners are subject to the Roth catch-up mandate for both increased limits.

Deemed Elections vs. Affirmative Elections

Plans may get affirmative elections from High Earners indicating whether they want amounts in excess of any applicable limit (402(g), ADP test, plan limit) to be a designated Roth contribution. A participant can choose to make Roth deferrals throughout the year count towards the $8,000* Roth catch-up mandate, if the plan permits earlier Roth contributions to count towards the requirement. Alternatively, the plan may deem that participants who exceed an applicable limit have elected to make designated Roth contributions, as long as they have an effective opportunity to change or opt-out of the deemed election.

Similar to the process for automatic enrollment plans, providing an effective opportunity means that the participants must be informed that catch-up contributions (based on the applicable plan limit) will be made on a Roth basis even if a participant has not made a Roth contribution election, along with instructions on how to request a change to the deemed election. The Final Regulations do not provide a specific mechanism for the distribution of this notice, but it is likely a best practice to include the notice with annual notices such as a safe harbor notice, a QDIA notice, and/or eligibility notices provided to newly eligible participants.

The deemed Roth election continues to apply even if the Form W-2 is later amended and the participant’s FICA wages no longer exceed the Roth catch-up threshold.

The Employer can choose one of two options regarding the timing of the deemed Roth election:

• Method 1: Once the participant’s total deferrals, including pre-tax and Roth contributions, get to the 402(g) limit, which is $24,500 for 2026, or
• Method 2: Switch the deferrals to Roth once the pre-tax contributions get to the 402(g) limit. Method 2 allows all Roth contributions made during the year to count towards the Roth catch-up mandate.

Following are two illustrations of Method 1 and Method 2:

The example above illustrates the appropriate mechanics for Deemed Election Method 1, but this affirmative election will result in $8,000 of Roth catch-up contributions and should not have triggered a Deemed Election Method.  See the chart below to see why an affirmative election in this amount would be compliant with the Roth catch-up mandate.

Compliant affirmative elections will e observed regardless of the Deemed Election Method selected by the plan sponsor, so Deemed Elections will not be triggered if participant elections equal or exceeded the following Roth contribution amounts in the table below, computed for three different pay cycles:

Although designated Roth contributions made through the plan year can be attributable to the Roth catch-up mandate of $8,000*, they are not technically a catch-up contribution if they are contributed prior to the participant reaching the 402(g) limit or the plan limit, if lower. If your payroll provider suggests labeling participant contributions as a catch-up starting with the first paycheck of the year, please refer to our previous blog explaining why this incorrect practice leads to operational errors: Catch-Up Contributions Must Exceed Some Limit.

For a plan to apply a deemed Roth catch-up election to a participant, the deemed Roth catch-up election must be set forth in the plan document. The deadline to amend plans for the provisions of Section 603 of the SECURE 2.0 Act is December 31, 2026. Collectively bargained plans and governmental 457(b) plans have a later deadline.

Available Corrections When Pre-Tax Catch-Ups Must be Recharacterized

Roth catch-ups could consist of:

1. Deferral contributions in excess of the 402(g) limit: $24,500 for 2026*
2. Contributions in excess of the amount permitted by the ADP test

Sometimes, catch-up eligible High Earner participant contributions are made on the pre-tax basis by mistake or because at the time of the contribution, the discrimination test has not been completed. When a plan fails the Actual Deferral Percentage (ADP) discrimination test, High Earners who are also HCEs may have to recharacterize some of their pre-tax deferrals as Roth catch-ups because of the failed ADP test.

Safe Harbor Plans and 403(b) Plans are not subject to the ADP test. For details regarding the available safe-harbor formulas and the mechanics of the ADP test, please refer to our previous blog: What are the Available Safe Harbor Plan Formulas?

Form W-2 Correction Method

If the Employer has not yet issued the participant’s W-2, a participant’s pre-tax catch-up contribution that was required to be a designated Roth contribution can be reported as a Roth contribution on the participant’s W-2 for the year of the deferral, as if the contribution had been correctly made as a Roth contribution. Additionally, the Recordkeeper must transfer the funds in the participant’s retirement account from the pre-tax source to the Roth source.

When using the W-2 Correction Method, the Employer must make sure that the Recordkeeper will not issue a Form 1099R for the reclassification from a pre-tax to a Roth source if the Form W-2 was updated. The Recordkeepers’ systems are often programmed to issue a Form 1099-R when funds are transferred from a pre-tax to a Roth source, so the utmost care must be taken to ensure the participant does not inadvertently end up with double taxation if the Employer updates the W-2 and the recordkeeper sends a Form 1099-R when the assets are reclassified to the Roth source.

Under the Form W-2 Correction Method, the contribution (not adjusted for allocable gain or loss) will be includible in the participant’s gross income for the year of the deferral as if the contribution had been correctly made as a designated Roth contribution.

The W-2 Correction Method is not permitted if the participant’s Form W-2 for that year has already been filed or furnished to the participant. An amended W-2 is not an option, but there is another solution that eliminates the potential for an inadvertent double taxation error, the In-Plan Roth Rollover Correction Method.

The In-Plan Roth Rollover Correction Method

Using the In-Plan Roth Rollover Correction Method, a plan would directly roll over the elective deferral (adjusted for allocable gain or loss) from the participant’s pre-tax account to the participant’s in-plan rollover Roth account and report the amount of the in-plan Roth rollover on Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) for the year of rollover. Thus, the amount directly rolled over to the participant’s in plan rollover Roth account would be the same as the amount reported on Form 1099-R, and the contribution (adjusted for allocable gain or loss) would be includible in the participant’s gross income for the year of the rollover.

A plan may use the in-plan Roth rollover correction method even if the plan does not permit participants to elect in-plan Roth rollovers under section 402A(c)(4)(E).

Plans must apply the same correction method for similarly situated participants. For example, a plan may provide for correction using the Form W-2 correction method for all participants for whom the Forms W-2 for that year have not been filed or furnished and for correction using the in-plan Roth rollover correction method for all other participants.

For a plan to be eligible to use either of the correction methods above, the plan sponsor or plan administrator must have in place practices and procedures designed to result in compliance with the Roth catch-up mandate at the time the elective deferral is made.

The Five-Year Holding Period Disparity Between Correction Methods

Pre-tax amounts transferred to a Roth source pursuant to the Form W-2 correction are subject to the 5-taxable-year-period that began with the first taxable year in which the individual made a designated Roth contribution under the applicable retirement plan.

On the other hand, consistent with the rules that require each in-plan Roth rollover to have its own 5-year holding period, pre-tax amounts reclassified as a Roth contribution using the in-plan Roth rollover correction method have their own 5-year holding period. As such, the Final Regulations provide that “any balances distributed within the 5-year taxable period beginning on January 1 of the year in which the in-plan Roth rollover correction is made will be subject to a 10% additional tax under IRC section 72(t) unless an exception applies under IRC section 72(t)(2).” Specifically, if the five-year holding period has not been met, the earnings portion of distributions from designated Roth accounts taken after age 59 ½ is subject to tax but not subject to the 10% penalty.

For details on how the 5-year holding period works for designated Roth accounts in retirement plans, (which differ from the Roth IRA rules), please refer to our previous blog on designated Roth accounts: 55 Things You Should Know About 401(k)/403(b)/457(b) Designated Roth Accounts.

The disparity in the application of the 5-year holding period between the two correction methods achieves administrative consistency with existing rules, but inconsistency between the tax treatment of similarly situated participants. Typically, I am an advocate of administrative simplicity as a valid priority, but not in this case. I would have allowed reclassifications done through the in-plan rollover correction method to be grouped with the existing Roth-source, as if the contributions had been correctly deposited as designated Roth contributions. Although the in-plan rollover correction method is easier, in my opinion, the W-2 correction method is more fair, even if it requires collaboration with the recordkeeper to reclassify the balances so that they agree with the updated W-2. Nobody said the rules have to be fair.

Refund/Distribution Method

If a participant does not want to make Roth catch-up contributions, or the deadline for the above two corrections has passed, the plan will distribute pre-tax deferrals in excess of the applicable limits plus earnings to the plan participant, and the Recordkeeper will issue a Form 1099-R.

Plan sponsors must not assume that the correction process will happen automatically. It is imperative for Employers to read their contracts with their various service providers, such as their third-party administrators or bundled recordkeepers, to understand the extent of their involvement that is necessary for the corrections to be processed.

Deadline to Correct IRC Section 414(v)(7) Roth Catch-up Failures

Roth Catch-up failures under IRC 414(v)(7) must be corrected by the end of the plan year following the plan year in which the failure arose. However, Roth catch-up failures are associated with the failure to comply with one of three applicable limits that have their own correction deadlines as follows:

Correction Not Required in Certain Circumstances

As a general matter, in order to remain qualified, any failure to meet the qualification requirements must be corrected even if all applicable statutes of limitations on assessment for the year in which the failure occurred have closed. However, the Final Regulations list two instances in which a failure to comply with the Roth catch-up mandate does not need to be corrected:

1. First, correction is not required if the amount of the pre-tax elective deferral that was required to be a designated Roth contribution does not exceed $250. For purposes of applying this $250 threshold, earnings and losses on the pre-tax elective deferral are not taken into account.
2. Second, correction is not required if the participant became subject to the Roth catch-up mandate as a result of an amended W-2.

The Answer is NO!

If reading all these rules has you thinking about eliminating Roth provisions or catch-ups from your plan, I don’t blame you, so here are some of the most common considerations to which the answer is NO!

1. Plans do not have to offer a catch-up provision.
2. Plans do not have to offer a Roth option.
3. Plans cannot require that ALL catch-up contributions be ROTH contributions.
4. Plans cannot make Roth available only for catch-up contributions.
5. Plans cannot make Roth available only to catch-up eligible participants.
6. Catch-up eligible participants who are not High Earners are not precluded from making catch-up contributions in a plan that does not have a Roth feature.

Rothification is Upon Us

In the end, 95% of all plans offer both Roth and catch-up so you will likely end up enduring the implementation of these rules with the rest of us. The mandatory Rothification that our Delaware Senator Roth never expected would become part of his legacy is upon us, motivated by immediate tax revenue, but ultimately beneficial for those forced to Rothify.

For reading much lighter than the mandatory Roth catch-up for High Earners, please refer to our melancholic blog about our Delaware Senator Roth and his legacy.

       

• Common Errors and Overpayments: Due to the complexity of retirement plan rules, errors are common, resulting in excess amounts (operational failures). If these excess funds are distributed to a participant, it becomes an overpayment failure, which can stem from issues like inaccurate testing, incorrect vesting, or ineligible distributions.
• Correction Relief for Inadvertent Overpayments: Under SECURE 2.0 and IRS Notice 2024-77, a plan sponsor is generally not required to seek repayment from a participant for an eligible inadvertent overpayment failure (an error that occurred despite compliance practices). However, the plan sponsor must typically make the plan whole (e.g., through a contribution) to avoid negatively impacting other participants.
• Administrative Choice vs. Required Correction: In contrast to the relief provided for eligible overpayments, all underpayments (when a participant does not receive enough money) must be corrected by the plan sponsor. For eligible inadvertent overpayments, plan sponsors often prioritize administrative simplicity and choose to let the participants keep the money, especially if the amount is not significant.

_______________________________________________________________________

Blog updated 12.1.2025 to include Section 6.02(5)(b) criteria. 

“Everybody Makes Mistakes, Everybody Has Those Days”…

Excess Amounts- Retirement plan provisions regarding eligibility, how to count hours of service, contributions, the definition of compensation, automatic enrollment, etc. require so much detailed recordkeeping and coordination between payroll personnel, HR, and the plan’s service providers, that the probability that a plan sponsor will allocate too much money, or not enough, to a participant’s retirement account is very high.

When excess amounts allocated to participant accounts are still in the plan when the error is caught, the plan sponsor will generally correct the operational failure by:

1. forfeiting employer sources and/or
2. distributing salary deferrals to be reported by the participant as income subject to taxes, but not penalties.

Excess amounts still in the plan must be corrected by taking the funds out of the participant accounts, except for deminimis errors.

However, excess allocation errors are sometimes detected after the participant has already received a distribution of the excess amounts. This is called an Overpayment Failure.

Overpayment Failures

Overpayment failures include:

• distributions of excess allocations to a participant,
• distributions in excess of the participant account balance or vested balance,
• ineligible hardship
• a terminating distribution without a distributable event.

In 31 years of auditing retirement plans, our distribution tests have uncovered all the following ineligible or excess distributions:

• Hardship reason not met: A participant doesn’t have a hardship as defined by the plan, but the sympathetic employer wanted to help them with their car repairs, credit car d bills, etcetera.
• Inaccurate ADP/ACP test: The discrimination testing was run with an inaccurate census and the refunds to the HCEs were too large.
• A change in recordkeeper or plan merger resulted in all transferred funds being allocated to the rollover source, leading to the distributions that wouldn’t have been available had the funds been allocated to the correct sources (participants can withdraw their rollover accounts at any time).
• A payroll person enters a termination date for him or herself into the web station and requests a terminating distribution, while still working for the employer.
• Employee transfer to another location coded as termination on the payroll, leading to an ineligible terminating distribution.
• Incorrect Source: A plan sponsor approves a hardship distribution from sources not permitted by the plan document.
• Vesting schedule disregarded and partially vested participants receive fully vested distributions.

In every case, our well-meaning client’s initial reaction is inevitably: “The money is gone, what do we do now?” Well, if the error is an eligible inadvertent overpayment failure, the answer could be…Do Nothing! Let It Be!

Eligible Inadvertent Overpayment Failures: Defined

Section 305(e) of SECURE 2.0 defines an eligible inadvertent failure as an error that occurs despite the existence of practices and procedures that strive to achieve compliance. Inadvertent overpayment failures must relate to:

1. payments that exceed amounts owed to the participant under the terms of the plan or the Internal Revenue Code, or
2. payments made before a distribution is permitted under the terms of the plan.

When the overpayment violates the Internal Revenue Code, such as the Section 402(g), 415, and 401(a)(17) limits, rather than just disregarding the terms of the plan, the distribution is not considered an eligible inadvertent failure, and the employer must:

1. Attempt to recoup the funds from the participant
2. Inform the participant that the overpayment is not eligible for rollover

Similarly, overpayments to disqualified persons under Internal Revenue Code Section 4975(e )(2) cannot be considered eligible inadvertent benefit overpayments. Disqualified people include:

• fiduciaries,
• owners of the company and their relatives (spouse, ancestor, lineal descendants and their spouses),
• officers,
• directors,
• 10% or more shareholders or partners,
• sole proprietors, and
• highly compensated employees who earn more than 10% of the total wages of the employer.

Eligible Inadvertent Overpayment Failures: Correction Relief

IRS Notice 2024-77 provides that if the overpayment is an eligible inadvertent failure, the plan sponsor does not have to seek repayment from the participant. Even if the employer takes no further action, the overpayment can be deemed to be corrected, even if the participant rolled it over to an IRA or another qualified plan. Hence, the participant does not owe any excise taxes for an ineligible rollover.

If the plan sponsor reallocates forfeitures, or the plan’s funding is subject to minimum funding requirements, the employer should make the plan whole by contributing the amount of the overpayment to the plan, so as not to negatively impact other participants by not attempting to recoup the overpayment from the participant.

If the plan sponsor chooses to pursue a reimbursement from the participant, and the participant is unable to repay, the distribution will be considered ineligible for rollover. If the participant completed a rollover to an IRA, excess contributions to the IRA will be subject to a 6 percent excise tax for every year the money remains in the IRA. The notice provided to the participant regarding tax treatment of the unreturned portion of the overpayment may be combined with a recoupment request.

The plan sponsor may also choose to amend the plan retroactively to increase the past benefit available to the participant or decrease the future benefit payments to the affected participants in order to adjust for inadvertent benefit overpayments. An amendment to increase past benefits cannot result in a different violation, such as exceeded limits and cannot reduce anyone’s accrued benefit, which would be inconsistent with an overpayment.

Ignore the Overpayments, but Correct the Underpayments

• Nothing in EPCRS Rev Proc 2021-30 or IRS Notice 2024-77 eliminates the requirement for the employer to make a participant whole when the participant account did not receive enough of a contribution allocation or when there was an underpayment. In fact, EPCRS specifically states that “corrective contributions are required to be made with respect to a current or former participant, without regard to the amount of the corrective contributions. “ Estimates are permitted when it is impractical or impossible to compute an exact correction, as discussed in the next section.
• Exceptions to a correction requirement apply only when participants receive more money than they should have, either because they are eligible inadvertent overpayment failures, discussed above, or because they are deminimis overpayments applicable to overpayments to disqualified persons, or overpayments that are a violation of the Internal Revenue Code.

Rev. Proc. 2021-30 Quotes Regarding Correction Exceptions

• Section 6.02(5)(c): Recovery of small Overpayments – Generally, if the total amount of an Overpayment to an Overpayment recipient is $250 or less, the Plan Sponsor is not required to seek the return of the Overpayment from the Overpayment recipient. Also, the Plan Sponsor is not required to notify the Overpayment recipient that an Overpayment of $250 or less is ineligible for favorable tax treatment accorded to distributions from the plan (and, specifically, is ineligible for tax-free rollover)
• Section 6.02(5)(b): Delivery of small benefits – If the total corrective distribution due a participant or beneficiary is $75 or less, the Plan Sponsor is not required to make the corrective distribution if the reasonable direct costs of processing and delivering the distribution to the participant or beneficiary would exceed the amount of the distribution. This section 6.02(5)(b) does not apply to corrective contributions.
• Section 6.02(5)(e): Small Excess Amounts – Generally, if the total amount of an Excess Amount with respect to the benefit of a participant or beneficiary is $250 or less, the Plan Sponsor is not required to distribute or forfeit such Excess Amount. However, if the Excess Amount exceeds a statutory limit, the participant or beneficiary must be notified that the Excess Amount, including any investment gains, is not eligible for favorable tax treatment accorded to distributions from the plan (and, specifically, is not eligible for tax-free rollover).
• Corrective contributions are required to be made with respect to a current or former participant, without regard to the amount of the corrective contributions.
• Reasonable estimates. If either (i) it is possible to make a precise calculation but the probable difference between the approximate and the precise restoration of a participant’s benefits is insignificant and the administrative cost of determining precise restoration would significantly exceed the probable difference or (ii) it is not possible to make a precise calculation (for example, where it is impossible to obtain plan data), reasonable estimates may be used in calculating appropriate correction.
  • For example, EPCRS indicates that if it is not feasible to make a reasonable estimate of what the actual investment results would have been, a reasonable interest rate may be used. Thus, if the probable difference between an approximate determination of Earnings and a determination of estimated earnings is insignificant, then the administrative cost of a precise determination would significantly exceed the probable difference, reasonable estimates may be used in calculating the appropriate Earnings. For this purpose, a determination of Earnings made in accordance with the rules of administrative convenience is treated as a precise determination of Earnings. Please refer to our previous blog for a discussion of the available earnings calculation options.
  • It is not clear whether the DOL would agree with the use of the DOL calculator outside of its own VFCP and self-reporting parameters, but EPCRS states that “the interest rate used by the Department of Labor’s VFCP Online Calculator is deemed to be a reasonable interest rate. For more details on the DOL’s new VFCP for late deferrals, please refer to our previous blogs:
    • New Voluntary Fiduciary Correction Program
    • New VFCP on Late Deposit

Administrative Simplicity Often Trumps Perfection

In most cases, plan sponsors choose to Let the Bygones be Bygones and let participants who received eligible inadvertent overpayments keep the extra money. Unless the overpayment amounts are significant, attempting to recoup the money from participants who likely already spent it, distributing notices, undoing previous rollovers to IRAs, explaining the tax consequences of the ineligible distributions, etc., is a drain on valuable administrative time and resources that would be better spent ensuring a timely Form 5500 filing and financial statement audit. In our experience, clients choose administrative simplicity over perfection, and they let participants keep the money.

       

• The 80-120 Rule for Audit Requirement: A retirement plan’s need for an annual audit is determined by counting participants with account balances on the first day of the plan year. The 80-120 rule is an exception that allows a plan with 80 to 120 participants to file as a small plan (no audit) if it filed as a small plan in the previous year.
• Audit Thresholds for Growing and Shrinking Plans: An audit is required when the participant count exceeds 120. For a shrinking plan that previously filed as a large plan (with an audit), it can switch back to filing as a small plan (no audit) once the count drops below 100 participants.
• Exceptions to the Rule: The 80-120 exception is not available for brand new plans (they count participants on the last day of the first plan year) or for welfare plans (like health/vision) that do not have a prior Form 5500 filing. Also, welfare plans generally do not require an audit unless they use a VEBA Trust and have over 100 participants.

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Each year, I review the audit requirement rules with pension professionals in all the specialties: investment advisors, third party administrators, recordkeepers, plan consultants, and more. This year, after our conversation, Renee Mrosowski from Summit Group Retirement Planners sent me an excellent summary of our conversation for my review. Her clear methodology is worth sharing, so if you are not sure whether your client’s plan needs an audit, follow her step-by-step summary and the answer will be clear:

Audit Rules: 80-120 and counting methodology

1. Count participants with balances (not forfeitures, not eligible) on the first day of the plan year.
   1. If between 80-120 people with balances, look at the prior year’s Form 5500 filing.
   2. If you filed a small plan Form 5500 last year, file as a small plan filer again.
   3. Repeat annually (it’s not limited to the first year) and continue to do this until the count exceeds 120 participants with balances on the first day of the plan year.
   4. The first year that you exceed 120 participants with balances, you no longer have the small plan filer exemption and must do an audit.
   5. EXAMPLE:
      1. Plan Origination Date = 4/10/2020
      2. Plan Year End Date = 12/31/2025
      3. Count Participants with Balances as of 1/1/2025
         1. If count is over 80 but under 120, and they filed as a small plan for the 2024 Plan year: file as a small plan (Short Form, no audit) for 2025.
         2. If count is over 80 but under 120, and they filed as a large plan for the 2024 Plan year: file as a large plan (Long Form, with an audit) for 2025, but only if the number of account balances is 100 or more. If the number of account balances drops below 100, then the plan will likely opt to file as a small plan. It is not typical to use the 80-120 exception when a shrinking large plan goes under 100 account balances. (Updated bullet with more detail 10 14 2025)
         3. If the count is over 120, file as a large filer for 2025.
      4. In Subsequent Years, repeat the process.
2. The 80/120 exception is not available to Brand New Plans (in their first year.)
   1. There is no prior year Form 5500 to refer back to.
   2. Since you cannot look at the prior year, you use the number of account balances on the last day of the plan’s first plan year.
   3. EXAMPLE:
      1. Plan Origination Date = 4/10/2025
      2. Plan Year End Date = 12/31/2025
      3. Count Participants with Balances as of 12/31/2025
3. The 80/120 exception is not available to Welfare plans (Vision, Health & Welfare) because they don’t file a Form 5500 when they are small so there is no prior year 5500 to refer to.
   1. Only count participants who have selected coverage; not dependents or eligibles.
   2. If you have a wrap document that includes all the benefits, you file a single 5500.
   3. If you have separate documents for each benefit, you file a 5500 for each one.
   4. If the plan is in a VEBA Trust, you must have an audit if you have over 100 participants.
   5. Fully insured, self-funded, or combination fully insured or self-funded plans don’t require an audit, regardless of size, because there is no “plan” to audit, the company has all the assets and pays all the bills from its own funds, unless there is a VEBA Trust.
4. At what point can you go back to being a small plan filer?
   1. When they go under 100 as of the first day of the plan year. (99 or less gets you out of the audit requirement.)
   2. If the plan is shrinking and it falls under 100 as of the first day of the plan year, they do not have to look back at the prior year when there was an audit done.
      1. Plan sponsors don’t normally invoke the 80-120 exception to get themselves another year of the audit requirement.
      2. Once the plan has less than 100 accounts on the first day of the plan year, they apply the general rule and apply as a small plan.

As Renee explained so well above, the 80-120 exception works well for a growing plan, but not so well for a shrinking plan. As an auditor, it doesn’t hurt my feelings when plan sponsors avoid the audit requirement. However, if a plan tends to teeter over and under the plan audit requirement, it may be wise for the plan sponsor to engage the auditor to perform agreed upon procedures in the off years to facilitate the test of opening balances when the plan goes back to needing an audit and as insurance that operations have remained compliant.

For additional iterations of how to properly count account balances, please refer to our previous blog called Form 5500 Participant Count: Cash or Accrual Basis? To Audit or Not to Audit?, where I discussed intriguing topics such as:

• whether a participant is deemed to have an account balance on the date of a plan merger;
• when the recordkeeper records a transfer-in on the settlement date after January 1st, for a transfer-out of another plan on December 31st of the previous year;
• MEP and PEP spinoffs;
• Profit sharing contributions made after year end attributable to the prior year.

The Rules are Simple, Not Easy

Like most rules affecting retirement plan administration, the participant balance counting rules are simple, they are just not easy.

This content was posted by Maria Hurd, CPA, RPA in collaboration with Renee Mrosowski | Summit Group Retirement Planners