Generally, if your company sponsors an employee benefit plan with 100 or more participants (which includes those individuals eligible to participate, whether they have elected to participate or not), the plan financial statements are subject to an annual audit by an independent auditor under the Employee Retirement Income Security Act of 1974 (ERISA). The audit is performed on behalf of all participants and, in part, should ensure there is a high likelihood participant records and accounts are being properly administered and adequately maintained. An audit will include detailed testing of participant data, contributions, benefit payments, income allocation, loans and other participant-related information.
The world of employee benefit plans is very complicated. It is very typical to find errors with the administration and operations of a plan during a plan audit. Here is a list of common errors, along with recommendations for preventing the errors and ways to correct them once detected.
The Responsibility Factor
- Understanding the Plan Provisions
All employee benefit plans subject to ERISA should have a written plan document. The plan document describes the provisions of the plan, which must be followed in order to maintain the plan’s tax qualified status. Understanding the terms included in the plan document is one of the most important aspects to a healthy administration; however, it is also where the most common errors occur.
The most common mistake typically relates to the definition of plan compensation. Misinterpretation typically occurs when certain items, such as bonuses and fringe benefits, are included or excluded from plan compensation. Further problems occur when there is a different definition of plan compensation for different types of contributions (e.g., compensation for purposes of employee deferrals is different from the definition for profit-sharing contributions).
Eligibility and Enrollment
Another common error relates to giving those qualified as eligible participants the opportunity to participate in the plan. The plan document sets forth the eligibility requirements (including age and service requirements), and participants should be extended the opportunity to participate within a reasonable period after meeting those requirements. Mistakes also occur when participants are given the opportunity and elect to participate in the plan, but their contributions don’t begin in a timely manner. Having effective internal controls in place to identify those who are eligible and allow them to begin participating in a timely manner would mitigate the participation risks. Such internal controls could include working with your service provider in order to identify those eligible to participate on a regular basis (preferably using an electronic mechanism), understanding that there still must be oversight by the plan administrator. The plan administrator could review the listing of newly eligible participants on a monthly basis to ensure the list is complete, accurate and that all newly eligible participants have been afforded the opportunity to participate and that participation, if elected, has begun in a timely manner. Another option could be to provide an automatic enrollment feature whereby employees have to elect out of participation.
There are many provisions within the plan document relating to everything from eligibility to distribution of plan assets. Reading and understanding the terms of the document is of utmost importance and can be done with the help of your third-party administrator, ERISA attorney or auditor.
- Timely Deposits of Employee Deferrals
The Department of Labor (DOL) has stressed the importance of timely remittance of participant contributions to 401(k) plans. Per DOL regulations, “a plan sponsor must deposit 401(k) deferrals that have been taken from their employees’ paychecks on the earliest date the employer can reasonably segregate these amounts from its general assets, but in no event later than the 15th day of the month following the month in which the employer withheld the contributions from the employee’s paycheck”.
When auditing this issue of timely deposits, the DOL has tried to establish a pattern of the earliest date when the employer can segregate employee contributions. At times the DOL has compared remitting employee contributions to remitting federal income tax and FICA withholdings. For example, if an employer normally remits FIT or FICA withholdings within three to four days of paying payroll, a similar amount of time should be necessary to segregate employee contributions and loan repayments and remit them.
Once a plan establishes that contributions can be submitted within a certain amount of time, the remittances should consistently follow the same pattern. Plan administrators should track the time it takes to deposit deferrals into a plan using a spreadsheet or other system in order to ensure the pattern is consistent. Any necessary deviations from the pattern, for unforeseen circumstances, should be documented in the event of a DOL inquiry.
- ADP/ACP Testing
Traditional 401(k) plans must be tested on an annual basis to ensure contributions for non-highly compensated employees are proportional to those made for highly compensated employees by way of the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. Corrections for failing these tests must be completed before the end of the 12th month following the close of the plan year for which the test was failed. If your plan works with a third-party administrator (TPA) or recordkeeper, the service agreement likely includes this service. In order to ensure the testing is done on a timely basis, plan administrators should work with the TPA or recordkeeper to provide the information needed to perform the tests in a timely manner and ensure proper follow-up is completed if the tests are failed. Another option is to design the plan as a safe harbor plan in order to avoid some of the testing altogether.
- Compliance with ERISA 404(c)
Many prototype plans include the provision that the plan intends to comply with ERISA Section 404(c). ERISA Section 404(c) provides a plan sponsor with liability protections on participant-directed retirement plans if the plan satisfies the conditions in the regulations, which include the following (This list is not all inclusive.):
- Communication to employees that the plan intends to comply with 404(c).
- Having a written Investment Policy Statement that includes a formal process for evaluating investment managers’ adherence to fund objectives, including a written evaluation report.
- Maintaining a file containing copies of all communications with participants, as well as the date, time and details of participant meetings.
- Offering investment information and education without crossing the line into participant-level investment advice.
Many plan sponsors are 1) not aware of this provision within their plan document and 2) do not comply with the steps necessary to maintain the protections. Plan administrators should review their compliance with ERISA section 404(c), including having an Investment Policy Statement and an investment committee that holds regularly scheduled committee meetings. Clearly and thoroughly documenting, via committee meeting minutes, both the decisions that have resulted from the investment committee’s periodic review and the rationale for such decisions is very important.
As previously mentioned, it is not unlikely to find errors within the administration of an employee benefit plan. There are many self-correction vehicles, including the Internal Revenue Service (“IRS”) Voluntary Correction Program. The IRS website also offers a “Fix-It Guide” for common employee benefit plan errors that is very helpful in determining how to correct an error.
A typical misconception is that hiring a service provider eliminates the responsibility of the plan administrator. While service providers can take on some of the responsibilities, the ultimate responsibility remains with the plan administrator. Ensuring effective internal controls over your employee benefit plan administration and understanding how the process works, from new participant to distribution of plan assets, will help mitigate potential errors and protect the plan sponsor from costly fines and corrections.
Nancy Cox is a Principal at The Bonadio Group.
She can be reached at email@example.com or 716.580.1601.