A missed after-tax election costs 40 percent unless caught early

A participant elects voluntary after-tax contributions to a retirement plan. Payroll never withholds a dollar. Under IRS rules, the plan's fix is a corrective contribution equal to 40 percent of what should have been withheld — unless the error surfaces early enough to matter.

A financial advisor in California brought the scenario to the Retirement Learning Center's ERISA help desk, and NAPA Net ran the exchange as its Case of the Week. It is a distinct kind of error: a payroll failure, a missed election, and a participant who loses a year of after-tax contribution space.

The IRS files this under the Employee Plans Compliance Resolution System (EPCRS) as a 'missed opportunity to make after-tax employee contributions.' Revenue Procedure 2021-30 prescribes the correction: the plan sponsor makes a qualified nonelective contribution (QNEC) equal to 40 percent of the missed after-tax amount. Earnings run through the correction date, and the plan may reduce the contribution for losses.

The election matters because it funds the move commonly called the mega backdoor Roth: a high earner pushes money beyond the annual elective-deferral cap and into a Roth account. A payroll error that kills the election costs a year of that headroom. The QNEC does not replace what the participant would have contributed; it prices the miss.

The participants who elect after-tax dollars tend to be the ones already maxing out pre-tax and Roth deferrals, the largest-balance people in the plan. For them, 40 percent of a missed year is a line item a compensation committee notices. The participant is usually the first to spot the problem, which means the plan finds out the slow way.

The correction is time-sensitive. If the plan gives the participant at least the last nine months of the plan year to make the after-tax contributions, up to the maximum that would have been permitted without the failure, no QNEC for the missed opportunity is owed. Any matching contribution that would have applied to the after-tax dollars still has to be made, adjusted for earnings.

For a calendar-year plan, that means roughly until the end of the first quarter. A brief glitch caught early costs a match correction at most. A glitch that lingers costs 40 cents on every dollar the participant was supposed to contribute.

The order of corrections matters. A plan with an actual deferral percentage or actual contribution percentage testing failure corrects that failure before applying this method. The 40 percent QNEC is the base charge; if the plan matches after-tax contributions, the corrective match rides on top, also adjusted for earnings. The whole bill is the sponsor's, not the participant's.

SECURE 2.0 loosened the process. The law expanded the IRS's Self-Correction Program for eligible inadvertent failures, and under Notice 2023-43 a qualifying failure may generally be self-corrected. The published case does not spell out the remaining conditions; the correction procedures have details worth reading before an advisor cites them.

For the advisor on a plan committee, the calendar is the tool. When a participant elects after-tax contributions at enrollment, audit payroll against the election inside the first pay cycles. The nine-month window is generous and finite; a sponsor who finds a missed election in December owes 40 percent, plus earnings, plus any match. The first payroll run after an after-tax election is the cheapest audit a plan will ever get.