Qualified nonelective contribution (QNEC)

What is a Qualified Non-Elective Contribution (QNEC?)

A Qualified Non-Elective Contribution (QNEC) is an employer contribution to a 401(k) or 403(b) retirement plan that meets specific regulatory criteria. QNECs are contributions made to correct a plan error or assist with passing nondiscrimination testing. They are immediately vested and subject to certain distribution restrictions, meaning they are not eligible for withdrawal until certain conditions are met, such as reaching retirement age, termination of employment, or other specified events.

The Importance of QNECs in Retirement Plans

The primary purpose of QNECs is to help employers maintain the compliance and qualification status of their retirement plans as outlined by ERISA regulations. They are predominantly used to correct plan operational failures, including issues related to missed deferral opportunities and failed non-discrimination tests such as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests.

Plan non-compliance can lead to severe penalties and loss of tax-favored status, making it imperative for employers to address any issues promptly.

What Constitutes a QNEC?

QNECs are characterized by the following specific attributes:

• 100% Immediate Vesting: Contributions made as QNECs must be fully vested immediately. This ensures that employees have an irrevocable right to these contributions without any vesting period.

• Distribution Restrictions: QNECs are subject to strict distribution rules, meaning they cannot be withdrawn until certain qualifying events occur, such as retirement, plan termination, or other specified conditions.

• Employer Contribution: QNECs are solely employer-funded contributions.

When QNECs are Used in Corrections

Correcting a Plan Operational Failure

A plan operational error is triggered by one of the following events: 

• An eligible employee is excluded from plan participation 

• An eligible employee fails to be enrolled under a plan’s Automatic Contribution Arrangement

• When there’s a failure to implement a participant’s deferral election

Each of these items could be considered a “Missed Deferral Opportunity” for the participant. Under the IRS Employee Plan Compliance Resolution System (EPCRS), employers can correct these errors by contributing a QNEC to the participant. The QNEC represents an opportunity for the participant to defer on a passed opportunity. The QNEC amount is based on the facts and circumstances that include the type of plan involved (ACA or not), and the length of the error. The QNEC will be between 0% and 50% of the failed election, plus 100% of the missed match on the amount that would have been deferred if the error hadn’t occurred. 

The QNEC should be allocated to the QNEC “source” in the plan’s recordkeeping system. The match may be placed in the discretionary match source or the QNEC source, but should be done so consistently across plan years. QNECs for deferral corrections are always adjusted for earnings. EPCRS includes multiple options for determining earnings. (The DOL VFCP calculator is not one of them and is not applicable for this purpose.)

Role of QNECs in Correcting ADP/ACP Test Failures

QNECs play a crucial role in correcting failures in the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. These tests ensure that retirement plan benefits do not disproportionately favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).

The ADP test compares the average deferral rates of HCEs to those of NHCEs, while the ACP test evaluates the average rates of employer-matching contributions and after-tax contributions. When a plan fails these tests, it indicates an imbalance in the distribution of plan benefits, necessitating corrective actions to restore compliance.

Steps to Correct Failed Tests with QNECs

To correct a failed ADP or ACP test, employers can make QNECs to NHCEs. These contributions effectively increase the average contribution rates of NHCEs, helping the plan pass the nondiscrimination tests. The process involves:

1. Calculating the Required QNEC Amount: Determine the contribution needed to raise the NHCEs’ average deferral or contribution rate. Check out our Learning Center article on how to calculate a QNEC amount and see more information on how they are used in corrections and missed contributions.

2. Allocating QNECs: Distribute the QNECs to the accounts of NHCEs, ensuring they meet the immediate vesting and distribution restriction requirements.

3. Filing Corrective Documentation: Ensure all necessary documentation is filed to reflect the corrections made.

Timing Requirements for QNECs

QNECs must be implemented promptly after identifying a document or testing failure.

For missed deferral opportunities, QNECs for missed deferrals must be contributed no later than the second year following the year in which the error occurred and should also include investment gains for the time period from the original deferral date until the deposit is made.

For use in ADP Tests, employers generally have one year after the end of the plan year being tested to make QNECs or QMACs to correct a failed NDT. Due to strict timing rules, QNECs and QMAcs cannot be used to correct a failed test if the plan uses the prior-year testing method.

Specifically, if the ADP/ACP test is not corrected within 12 months after the Plan Year End (PYE), a one-to-one QNEC is required, meaning the QNEC contribution correction must match the refunds made to HCE shortfall exactly to meet regulatory requirements and keep the trust in balance.