A missed deferral opportunity (MDO) happens when an eligible participant's payroll contributions are not properly withheld from their pay. This can result from a plan error, an oversight, or a delay in giving an employee the chance to participate in the plan. Because deferrals need to be withheld before a participant gets their compensation, these issues typically cannot be fixed by rerunning payroll — instead, alternate corrections are needed. This article explains why MDOs happen, how to calculate one, and how to correct it.
MDOs generally fall into two categories.
Common reasons for failure to implement:
An incorrect deferral percentage is applied to the participant's compensation (the percentage was too low)
A participant is prevented from making catch-up contributions because of incorrect payroll capping, an invalid birthdate, or a similar issue
The plan sponsor does not apply a deferral election to an off-cycle payroll (most commonly, a bonus payroll)
The plan sponsor excludes certain compensation when determining the deferral amount (most commonly with bonuses or commissions)
A participant is not automatically enrolled on time
A qualified automatic contribution arrangement (QACA) plan does not change a participant's contribution rate due to an auto-escalation requirement
Common reasons for late enrollment:
The plan administrator or sponsor was late adding a new participant to the company roster or payroll, or hire dates or other data used to determine eligibility were inaccurate
An eligible employee did not get an invitation to enroll in the plan (possibly due to an incorrect or missing email address)
In most cases, plan sponsors can self-correct MDOs through the Internal Revenue Service (IRS) Employee Plan Compliance Resolution System (EPCRS). A formal submission to the IRS is typically not required.
MDOs are usually corrected through qualified nonelective contributions (QNECs). Plans must also contribute any missed employer matching or nonelective contributions for the affected pay periods. The missed matching contribution is calculated based on the MDO.
Per IRS guidance, calculations for MDO corrections are finalized after the end of the year to account for contribution limits. Estimated calculations are available throughout the year and become finalized after annual plan administration is done. A report of finalized calculations is distributed to plan sponsors before corrections are processed.
Before determining the amount of a QNEC or missed match, you need to calculate the MDO. To calculate the MDO, follow these steps.
Figure out what percentage of compensation should have been withheld but was not.
Failure to implement
Affirmative election in place. If the participant manually selected a contribution rate and the percentage withheld was lower than their election, the MDO is the difference between the two amounts.
River elected to have 6% withheld, but only 3% was withheld. River's MDO is the 3% difference.
Rory elected to have 6% withheld, but 0% was withheld. Rory's MDO is the 6% difference.
Not auto-enrolled on time. If the participant was given an opportunity to defer, made no election, and should have been automatically enrolled, the MDO is the default deferral rate as determined by your plan document.
Not auto-escalated on time. If the participant was automatically enrolled under a QACA and the auto-escalation was not applied on time, the MDO is the auto-escalation amount as determined by the plan document.
Amelia was automatically enrolled at 3%, and the plan document required increasing the election by 1% each year, but she continued to receive 3%. Amelia's MDO is 1%.
Late enrollment
If an eligible employee was not given an opportunity to defer, the automatic enrollment percentage is typically not used. In this case, the amount depends on the plan design.
Non-safe harbor plan. Use the average deferral percentage (ADP) for the year of exclusion. The ADP is the average amount of deferral divided by total compensation. If the employee is a highly compensated employee (HCE), use the HCE ADP for the year. If the employee is a non-highly compensated employee (NHCE), use the NHCE ADP for the year of exclusion. The plan cannot use the otherwise excludable employee rule or restructuring to artificially reduce the ADP.
Non-elective safe harbor but not a QACA plan. The MDO is 3%.
Safe harbor match and not a QACA plan. The greater of 3% of compensation or the maximum deferral percentage for which the plan provides at least a 100% matching contribution (for example, a safe harbor basic plan would use 3%).
QACA safe harbor plan:
During the initial period, the MDO is 3% (even if the rate of automatic enrollment for those years is higher than 3%)
After the initial period, the missed deferrals are the automatic contribution percentage stated in the document
Add up the gross compensation for the pay periods during the failure.
Multiply the missed deferral percentage (step 1) by the gross compensation (step 2).
Look at the total amount deferred in the plan year and cap the MDO to the annual deferral limit (including any reported external deferrals). Make sure the limit is adjusted for any participants who are eligible for catch-up contributions. If the participant already deferred the maximum amount allowed for the plan year, the MDO is 0.
Once you have an MDO amount, multiply the MDO by the applicable QNEC percentage to determine the QNEC amount. The MDO is also used to determine the missed match for the applicable pay period.
A QNEC is a special kind of employer contribution that must be 100% vested. The IRS caps the QNEC at 50% of the MDO since the employee has already gotten the compensation that would have been used to fund the deferral. There are several exceptions to the requirement to contribute a 50% QNEC — most of which require notice of the correction to be sent to the participant no later than 45 days after the correct deferrals begin.
EPCRS has several safe harbor corrections that can lower the QNEC contribution required, although it is always permissible to correct a missed deferral with a 50% QNEC.
Note: Because the missed match is based on the MDO rather than the QNEC, a missed match may still be owed even when the QNEC is 0%.
For Gusto Retirement plans, there are two scenarios that may result in a 0% QNEC.
Plans with automatic contribution safe harbor (notice required). The missed deferral must be corrected (the correct deferral amount must begin) by the 9 1/2-month period after the end of the plan year of the failure. In the case of an employee who notifies the plan of the error, the date of the first payment of compensation made by the employer to the employee on or after the last day of the month following the month in which such notification was made, and the correction notice must be provided within 45 days after the correct deferrals begin. This safe harbor rule applies to participants who were subject to an automatic contribution feature, whether or not the participants made an affirmative election.
Brief exclusion (notice not required). This exception applies only to missed contributions in January, February, and/or March of a calendar year (since all Gusto Retirement plans are calendar-year plans) due to late enrollment. The employee must have the opportunity to defer for at least the last nine months of the plan year, and during that period, the employee must have the opportunity to make elective deferrals in an amount not less than the maximum amount that would have been permitted if no failure had occurred.
Note: EPCRS also provides for a three-month safe harbor, but because all Gusto Retirement plans have automatic enrollment, the 9 1/2-month rule is much longer and eliminates the need to apply this option.
Three-year safe harbor (notice required). The missed deferral must be corrected (the correct deferral amount must begin) by the first payment of compensation made on or after the last day of the third plan year following the plan year in which the failure occurred, and the correction notice must be provided within 45 days after the correct deferrals begin.
The notice must be provided within 45 days of the correct deferrals being withheld and must include:
Information about the failure and a statement that correct deferrals have begun
Confirmation that corrective contributions will be made (if applicable)
A statement that the participant can increase their deferral percentage to make up for the missed deferrals (if applicable)
Note: EPCRS has a special rule for participants who are excluded from making catch-up contributions, requiring a 50% QNEC in this case. Since Gusto Retirement has no special catch-up election (all deferral percentages apply equally to regular deferrals and catch-up), this rule should rarely, if ever, apply. 50% QNECs are always permissible, and a plan sponsor may elect to correct using a 50% QNEC if the circumstances warrant that correction.
Regardless of whether a QNEC is owed for an MDO, any missed matching contributions and/or nonelective contributions must be corrected if there is an MDO. The QNEC percentage is not relevant to this requirement.
If there is an MDO and the plan provides for matching contributions for the period that the missed deferral applied, there is a missed matching contribution that must be fixed — even if the QNEC is 0%.
Note: Because nonelective contributions are calculated per pay period at Gusto Retirement, a nonelective contribution is usually missed at the same time there is an MDO. A nonelective contribution may still be required even if there is no MDO, since no deferral is required for a nonelective contribution.
To determine the missed match, use the MDO calculation above and make sure the matching contribution is limited to the annual compensation limit. Include all matching contributions made so far for the plan year, and make sure any missed match does not take the participant over the limit.
To learn more about the EPCRS, visit the IRS website.