Now is the time to make sure your company’s retirement plan is in order and can sustain a rigorous Department of Labor or Internal Revenue Service review.

The DOL and 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 with Form 5500.

Eight common audit findings and the steps you can take to identify issues within your plan before an audit.

1. 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. Many plan vendors will provide the sponsor with amendments, but it is the sponsor’s responsibility to formally adopt them.

2. 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’s 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’s 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.

3. Using 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’s easy for something to get programmed incorrectly that, in turn, incorrectly calculates deferrals. Plan sponsors need to make sure that what’s 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.

4. Not depositing participant contributions on 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. 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.

5. 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’s a good practice to periodically pull a representative sampling of employees (new hires, transfers, rehires and part-time employees) and review eligibility procedures.

6. Improper participant loans, 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 provisions in the plan document properly reflect 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.

7. 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 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.

8. Forgetting to file 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 here. 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.

Content provided by LBMC professional, Jenny Merritt.

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.

Content provided by LBMC auditor, Mark Blackburn.

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.