Many employers offer 401(k) retirement plans to their employees. This makes sense since employers would naturally want to help their employees save for a comfortable retirement. Who doesn’t like being a decent person? It makes even more sense when you consider that, if run properly, 401(k) plans don’t require a significant investment of time or money.
As with most things in life, however, there is a catch — Retirement plans are regulated by both the U.S. Department of Labor and the IRS, which means that 401(k) plans come with a long list of rules and regulations. Running afoul of these rules has serious consequences that can quickly make plans much less affordable from both a monetary and time-investment standpoint. If you stray far enough from the right path, your plan could even lose its qualified status. This means that contributions, both employee and employer, would be taxable. If you completely ignore your plan and leave it in a state of neglect, you might end up having to sit down with all your employees to explain that all their 401(k) deferrals are going to show up on their W-2 as taxable wages.
As a firm, Baker Newman Noyes audits close to 200 plans each year. As a result, our auditors have pretty much seen it all: the good, the bad and the ugly. Following is a list of some of the most common errors, compliance and control issues, and “oops” moments our auditors have run into.
Almost all of the employers Baker Newman Noyes works with look to outside service providers to help in the management of their plans. Investment advisers help select and monitor funds; third-party administrators (TPAs) track participant accounts and handle many of the everyday transactions of the plan, like loans and distributions; and custodians hold the assets for the plan. But who is in charge of monitoring the various service providers? Remember that catch?
Legally, the plan sponsor and the plan administrator hold fiduciary responsibilities for the plans they administer. When something goes wrong, the DOL and the IRS will be looking to the company for answers. Explaining to them that you thought it is someone else’s responsibility will not be looked upon favorably.
While not all-encompassing, the following is a short list of controls and/or review activities that auditors regularly find are not in place, even though they should be:
- The sponsor should have a formal committee to provide oversight to the plan. The committee should meet regularly and maintain minutes. It should be responsible for approving any plan amendments, reviewing plan fees and expenses, and monitoring the performance of plan investments.
- The sponsor should review the investment statements to ensure the proper contribution amounts actually made it to the plan.
- A reconciliation should be performed at least quarterly between the participant records and the investment statements.
- Many plans delegate most, if not all, responsibilities related to loans and distributions to their TPA. However, best practice is that all new loans and distributions should be reviewed and approved by the sponsor.
- The sponsor should monitor the TPA to ensure all proper compliance testing is being performed on an annual basis.
- The Form 5500 should be reviewed in detail by the sponsor to ensure accuracy before it is filed each year.
While not necessarily a problem on the surface, every year our auditors run into several plans with an extreme number of investment choices (for instance, 125 participants and 50 mutual funds or more). As noted above, the plan committee is responsible for monitoring the investments. It gets difficult to demonstrate that you are performing these duties properly when you have almost as many investment options as you have participants.
Another suggestion is to be fully prepared for your auditor, assuming your plan requires an audit. Many of the schedules auditors request and questions they ask lead you towards best practices.
Not Following the Plan Document
The plan document is the legal instrument that dictates how your plan should be run. In other words, it is the first and last word on how your plan should be operating on a daily basis. Auditors often run into situations where the plan is being operated (almost always unintentionally) in a manner that is inconsistent with how the plan document is written. The answer most often heard is, “That is the way we have always done it.” It cannot be stressed enough how important it is to review your plan document or adoption agreement from time to time. Another thing to keep in mind is that (as much as it pains auditors) there is almost always no concept of materiality when dealing with the DOL or the IRS.
Following is a list of common errors our auditors have seen related to failures to follow the plan document:
Many plans include provisions that allow the employer to force former employees with small balances to move their money out of the plan. Our auditors see many instances where no one is tracking this. While this isn’t a problem per se, remember that you are responsible for everyone’s money, and fewer people means less tracking. Our auditors have also seen instances where former employees who leave their money in the plan have led to the participant count-crossing the threshold that requires an audit.
- Failure to follow the plan document’s definition of eligible compensation — The concept is very simple: Somewhere in your document there is a section that describes which wages will be considered compensation for purposes of calculating employee deferrals, match amounts, etc. An example would be W-2 wages. The application of these rules can be much more difficult. Under the assumption of the W-2 wages definition noted above, what happens to the group term life, which is imputed income on a pay stub, or to the $50 gift card you gave your employees around the holidays? Did you remember to withhold 401(k) deferrals from amounts that may not even represent cash in an employee’s pay check?
- A plan changes TPAs, and a new plan document is written — The intent of the plan is to operate exactly as before, but, when the new document is written, an oversight occurs. Perhaps bonuses have always been excluded for the purposes of employee deferrals, but this language is inadvertently omitted from the new plan document.
- Many large service providers use a prototype plan document that has been preapproved by the IRS to meet the requirements of a qualified plan. Essentially, all the employer is required to do is “check the box” for the options their plan would like to use. This is very convenient, but there can literally be a hundred different boxes to check. Think of the example above with the bonuses; it would be very easy to forget to check that box.
There are a myriad of other rules and regulations that a plan is required to follow. Here are some of the issues we have seen, though not quite as frequently as fiduciary or plan document problems.
Matthew Prunier is a senior manager in the employee benefits practice at Baker Newman Noyes in Portland, Maine.
- DOL rules generally state that employee deferrals must be remitted to the plan as of the earliest date on which these contributions can reasonably be segregated from the employer’s general assets, but in no event later than the 15th business day following the end of the month in which amounts are contributed by employees and withheld from their wages. The DOL has increased scrutiny of the timeliness of remittance of employee contributions and is enforcing the “earliest date” requirement of the regulations.
- We have seen contributions remitted four days after a particular pay date for 25 pay periods during a year, and then on the 26th period, the funds were remitted on day one, and the DOL calls all of the four-day remittances late since the plan has demonstrated the ability to remit funds before that time frame. Also try to be mindful of having a backup. Baker Newman Noyes has clients who are terrific with their remittances except for the two weeks each year that the regular responsible individual is on vacation. (Small plans, those with fewer than 100 participants, are able to use a seven-business-day safe harbor for their contributions).
- For each plan or prototype plan, the IRS will issue a determination letter that indicates whether the plan meets the requirements to be considered qualified. A new letter should be obtained from time to time in accordance with regulations or whenever significant changes are made to the plan.
- Each plan is required to have a fidelity bond in place. Keep in mind that the amount is dictated by various regulations; the plan (not the sponsor) needs to be directly named as the beneficiary, and a fidelity bond is not the same as fiduciary insurance.
- Each plan is required to provide participants with information regarding how the plan’s investments are performing compared to benchmarks, as well as certain information related to plan fees. Additionally, plans are required to review expenses paid to covered service providers to determine that the services are necessary and the fees are reasonable.
- In many cases, plans allow participants to withdraw money to support a hardship. These circumstances should be documented, and deferrals are required to be suspended for six months following the distribution.
- There are rules for every plan that dictate when employees are allowed to become participants in the plan.
- Plans are required to communicate with participants on a regular basis. Many times, these communications come from the TPA. You should make sure these are being distributed properly. Examples are quarterly investment statements, summary plan documents, summary of material notifications, and annual safe harbor notices.
He can be reached at MPrunier@bnncpa.com or 207.791.7527.