The Department of Labor (DOL) and the Internal Revenue Service (IRS) have increased the number and frequency of retirement plan audits. Although many audits are triggered by an employee complaint, most are random, or triggered by an issue in the Form 5500. Now is the time to make sure your retirement plan is in order and can sustain a rigorous DOL or IRS review. Below is a list of 8 common audit findings and the steps you can take to identify any issues within your plan before facing an audit.
- Not keeping plan document up to date.
If any rules or regulations pertaining to plans have changed, plan documents must be changed to reflect those changes as well. Many plan vendors will provide the sponsor with amendments, but it is the sponsor’s responsibility to formally adopt them.
- Not following plan documents.
The plan document serves as the foundation for plan operations; simply put, it is the operating manual for the plan. It is important to understand plan documents and consult them upon making decisions. If operations have changed, plan documents need to be updated to be current and accurate. It is a good idea to conduct a document/process audit every couple of years. Don’t assume that the way things have always been done is supported by the legal document governing the plan.
- Using the incorrect definition of compensation to calculate deferrals.
A big problem that a lot of retirement plans face is the proper application of the plan’s compensation definition. With numerous payroll systems and pay codes, it is easy for something to get programmed incorrectly that incorrectly calculates deferrals. Plan sponsors need to make sure that what is happening operationally is in agreement with the plan document. Read the document’s definition of eligible compensation and check it against a few employees’ payroll records to verify that all eligible compensation was included when calculating their deferrals. If there are discrepancies, corrective distributions or contributions may be needed.
- Not depositing participant contributions on a timely basis.
Late payroll deposits are one of the most common DOL audit issues. The law requires that participant contributions be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets. However, the deposit should never occur later than the 15th business day of the month following the withholding of the employee’s wages. The word “reasonably” is not defined under federal law or guidance for purposes of determining whether a deposit of deferrals has been made timely. Generally for larger businesses, a timely deposit will most likely happen within a couple of business days after the payroll withholding. There is a small business safe harbor that applies to businesses with fewer than 100 participants. The safe harbor states that 401(k) deposits for a small business are timely if they are made within seven business days from the date the contributions were withheld from employee wages. We recommend that the plan sponsor examine the company’s payroll process to determine the date that contributions can reasonably be segregated from assets and use this date as the maximum deadline for remitting contributions.
- Not following eligibility requirements.
The plan document spells out employees’ rights to retirement benefits and the formulas for determining them based on the correct application of service and/or age requirements of the plan regarding eligibility for participation. To comply with those requirements, the plan sponsor needs to maintain accurate service records for all employees and have a process built into their system to inform them when the requisite hours are reached by each employee. If these records are incorrect or a system is not in place, the benefits provided may be incorrect. It is a good practice to periodically pull a representative sampling of employees (new hires, transfers, rehires, and part-time employees) and review eligibility procedures.
- Improper participant loans and hardship withdrawals.
Plan documents provide that hardship distributions can only be obtained for certain very specific reasons, and loans are permissible only when they comply with certain standards. Failure to ensure that these legal requirements are met can result in a distribution that is not authorized under the terms of the plan document. We recommend that employers check to make sure that the provisions in the plan document properly reflects how the plan is actually administered. The employer can check for compliance by picking a representative sampling of employees who have taken a hardship distribution or loan and reviewing the paperwork that relates to those loans to make sure everything is in order and complies with legal requirements.
- Failing to perform ADP/ACP nondiscrimination testing.
The Employee Retirement Income Security Act requires testing to prove 401(k) plans do not discriminate in favor of highly compensated employees. The IRS believes that one of the areas of greatest failures for 401(k) plans is the failure to perform this required discrimination testing and correct any errors by the proper deadline. Nondiscrimination testing is usually performed by the record-keeper or a third-party administrator, but plan sponsors should understand the basics, including the consequences of failing. Employers should examine these tests for errors, such as employees listed with zero compensation or employees on the list who have deferral percentages greater than plan limits.
- Forgetting to file the Form 5500.
A Form 5500 has to be filed with the DOL every year. Sometimes it can fall through the cracks, especially in small companies. For larger plans, failure to file the Form 5500 can occur when mandatory audits are not completed in time to be included with the Form 5500 as required. Plan sponsors should develop an annual compliance checklist that includes completing and filing the Form 5500. Another option is to outsource the filing of Form 5500 to a reliable third party administrator.
With continuous monitoring and periodic self-audits, retirement plan sponsors can avoid many of the problems detailed above. As for plans that are not in compliance, the IRS and DOL have several programs for voluntary self-correction of operational errors and fiduciary violations. If caught early enough, many issues can be easily fixed by the plan sponsor.