The improper exclusion of an eligible employee is a common error that retirement plans commit. This can happen for any number of reasons. In some cases, plan administrators make a mistake when applying the plan’s eligibility requirements or the plan’s entry dates. In other instances, there are misunderstandings of the rules pertaining to the plan’s early eligibility provisions or rehired workers.

In order to assist in correcting these common errors, the Internal Revenue Service has provided a correction method under EPCRS (Rev. Proc. 2008-50). The methodology for correcting such an error depends on the type of plan and the benefits offered.

Typically, a plan can correct the improper exclusion of an eligible employee by making a qualified non-elective contribution equal to the missed deferral opportunity, which totals 50% of the missed deferral. The missed deferral is calculated by multiplying the actual deferral percentage for the employee group to which the employee belongs by the employee’s compensation for the portion of the plan year for which the employee was improperly excluded.

Let’s say an employee who earns $50,000 a year was improperly excluded for six months. If the actual deferral percentage was 4% for the employee’s group, then the missed deferral opportunity would be calculated as follows:

$1000 (4% x $25,000)
x 50%
$500 = missed deferral opportunity

If the employee was excluded for less than three months and has at least 9 months in which to defer, the employer does not need to make a corrective contribution so long as the employee would be able to make the same amount of deferrals as she would have made if she were a participant in the plan for the full plan year.

The brief exclusion rule does not apply to the matching portion of the plan.