For companies that offer their employees a 401(k) retirement plan, it is important to make sure that the plan is being operated properly.

It’s not unusual for the IRS to conduct audits of qualified employee benefit plans, including 401(k)s. Retirement plan sponsors are expected to stay in compliance with numerous, frequently changing federal laws and regulations.

  • Have you identified all employees eligible for your 401(k) plan and given them the opportunity to make deferral elections?
  • Are employee contributions limited to the amounts allowed under tax law for the calendar year?
  • Does your 401(k) plan pass nondiscrimination tests?
  • Traditional 401(k) plans must be regularly tested to ensure that the contributions don’t discriminate in favor of highly compensated employees.

If the IRS uncovers compliance errors and the plan sponsor doesn’t fix them, the retirement plan could be disqualified.

List of questions on common errors found in retirement plan operations

Are the provisions of the plan document being applied appropriately in plan operations?

The plan document governs the operation of the plan. It is crucial to ensure the plan sponsor is following all of the provisions included in the plan document.

Is the correct definition of compensation used to determine how much employees can contribute?

There are many different definitions of compensation used in plan documents. Especially if you have changed payroll systems, payroll providers or amended your plan during the year, it is important to make sure your payroll system or payroll provider uses the correct definition of compensation when withholding contributions from your employees.

Are employer matching or profit-sharing contributions appropriately made and allocated?

One common error is caused by eligibility requirements for employees to participate in employer contributions. Reviewing length of service information and other eligibility provisions will help ensure that employer contributions are made properly and allocated to employees correctly.

Were all eligible employees identified and given the opportunity to contribute to a 401(k) account?

Generally, treat each employee who receives a W-2 form as an eligible employee unless you can properly exclude that employee under terms of the plan document. If a third party is responsible for employee enrollment, consider reviewing their procedures for making sure all newly eligible employees are being provided enrollment information annually.

Has the company promptly deposited employee contributions?

This continues to be a significant focus area for the Department of Labor. Small plans (less than 100 employees) have a seven-day safe harbor to deposit funds. Unfortunately, large plans do not fall under this safe harbor provision and should deposit funds as soon as administratively possible after each payroll period. Failure to do so could lead to the plan sponsor incurring fines and penalties.

Do loans to participants follow the plan document and meet IRS requirements?

Many 401(k) plans allow participants to borrow money from their accounts, and some plan documents provide varying limitations on the amounts and number of loans. Plan sponsors should review these limitations and make sure loans are handled properly.

Were hardship distributions made properly?

Some plans are permitted to make distributions to participants facing an immediate and heavy financial need, but there are a number of limitations on the amount that can be distributed and acceptable uses for the money. Plan sponsors should review applications for hardship withdrawals closely to ensure proper use of these funds.

You should consider consulting with your financial adviser or third-party administrator to assist you in reviewing this list and determining what options you might have to correct any errors you find.

Correcting Retirement Plan Errors

The administration of retirement plans is very complex and, even with best efforts, failures can occur.  These failures often are unintentional and may seem minor, but they can have serious consequences (including plan disqualification), which can result in adverse tax consequences for the plan sponsor.  Fortunately, the Department of Labor (DOL) and Internal Revenue Service (IRS) have established various programs intended to encourage sponsors to voluntarily correct plan failures before facing an audit.

Department of Labor Employee Benefits Security Administration

The DOL Employee Benefits Security Administration (EBSA) is responsible for administering and enforcing the fiduciary, reporting and disclosure provisions of Title I of the Employee Retirement Income Security Act of 1974 (ERISA).  The DOL has two voluntary self-correction programs available to plan sponsors who need help meeting ERISA requirements.

1. Voluntary Fiduciary Correction Program

The Voluntary Fiduciary Correction Program (VFCP) allows anyone who may be liable for fiduciary violations under ERISA, including employee benefit plan sponsors, officials, and parties in interest, to voluntarily correct certain fiduciary violations and avoid certain penalties provided they comply with the criteria and satisfy the procedures outlined in the VFCP. The VFCP provides descriptions of 19 categories of violations, including delinquent participant contributions, defaulted participant loans, and benefit payments based on improper valuation of plan assets, and their methods of correction. The steps outlined below will assist in fully correcting violations.

Step 1: Identify any violations and determine whether they fall within the transactions covered by the VFCP.

Step 2: Follow the process for correcting specific violations (e.g., improper loans or incorrect valuation of plan assets).

Step 3: Calculate and restore any losses or profits with interest, if applicable, and distribute any supplemental benefits to participants.

Step 4: File an application with the appropriate EBSA regional office that includes documentation showing evidence of corrective action taken.

2. Delinquent Filer Voluntary Compliance Program

The Delinquent Filer Voluntary Compliance Program (DFVCP) provides benefit plan sponsors the opportunity to file overdue, incomplete or incorrect Form 5500 annual reports and pay reduced civil penalties. The DFVCP is only available to plan administrators with filing obligations under Title I of ERISA who comply with the provisions of the program and who have not been notified in writing by the DOL of a failure to file a timely form 5500.  The basic penalty under the program is $10 per day for delinquent filings with a maximum penalty of $750 for a small plan and $2,000 for a large plan for a single late annual report.  For plan administrators who have failed to file an annual report for a plan for multiple years, the maximum penalty is $1,500 for a small plan and $4,000 for a large plan regardless of the number of late annual reports filed for the plan at the same time.

Internal Revenue Service Employee Plans Compliance Resolution System

The IRS Employee Plans Compliance Resolution System (EPCRS) correction programs help plan sponsors of qualified retirement plans keep their plans in compliance with Internal Revenue Code requirements. The EPCRS offers three programs for correcting plan errors.

Self-Correction Program – The Self-Correction Program (SCP) allows a plan sponsor to correct insignificant operational errors at any time without contacting the IRS or paying any fee. Significant operational failures may still be corrected under this program if action is taken in a timely manner.  An example of an operational error would be not following the written terms of the plan.  Since nothing is filed with the IRS, the plan sponsor should maintain adequate records of the steps taken to correct the error in the event of a plan audit.

Voluntary Correction Program – Some failures are not eligible for SCP and some plan sponsors prefer a written IRS approval of the correction.  In these instances, the failures may be corrected under the Voluntary Correction Program (VCP). This program permits a plan sponsor to, any time before an audit, pay a fee and receive IRS approval for correction of plan failures.  To receive IRS approval, the plan sponsor should submit a user fee and a VCP submission, which describes the failure and the methods used to correct them and prevent them from happening again, to the IRS.

Audit Closing Agreement Program – The Audit Closing Agreement Program (ACP) can be used by plan sponsors that have significant issues discovered as a result of an IRS audit of the plan.  The plan sponsor makes the appropriate corrections and then pays a sanction negotiated with the IRS.

When faced with fiduciary violations or operational errors, plan management should consult with their plan auditor and ERISA counsel to properly determine the overall impact of the deficiency and to assess the best available correction method.

More information on the DOL and IRS voluntary correction programs may be found by visiting the websites below.

https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/correction-programs

https://www.irs.gov/retirement-plans/correcting-plan-errors

What happens if the retirement plan is disqualified?

Tax law and administrative details that may seem trivial or irrelevant may actually be critical to maintaining a plan’s qualified status. If a 401(k) plan loses its tax-exempt status, each participant is taxed on the value of his or her vested benefits as of the disqualification date. That can result in large tax liabilities for participants.

In addition, contributions and earnings that occur after the disqualification date aren’t tax-free. They must be included in participants’ taxable incomes. The employer’s tax deductions for plan contributions are also at risk. There are also penalties and fees that can be devastating to a business.

Withdrawals made after the disqualification date cannot be rolled over into other tax-favored retirement plans or accounts (such as IRAs).

Retirement plan errors can be voluntarily corrected

The good news is that 401(k) plan errors can often be voluntarily corrected. We can help determine if changes should be made to your company’s qualified plan to achieve and maintain compliance.

If you have questions, we can help.