Mistakes happen. Many, like hitting reply all on an email, are merely annoying. Others are more costly and troublesome. If you are the plan sponsor or administrator of your organization's 403(b) or 401(k) plan, you can save yourself time and money by understanding common retirement plan problems, and knowing how to prevent and fix them.
Compensation
Mistake: Compensation amounts used to compute contributions and perform annual compliance testing must match the plan document's definition. W-2 wages is a common but often misunderstood definition. For example, many plan sponsors don't realize this includes all taxable wages, including non-cash fringe benefits such as group term-life insurance premiums or taxable domestic partner health insurance benefits. And unless otherwise excluded in the plan document, this definition also includes bonuses, awards, and stipends that are considered taxable income and reported on W-2 forms.
The Fix: Confirm that the plan's definition of compensation properly reflects your intentions and that payroll software and systems are set up to use the correct compensation when calculating employee and employer contributions.
If contributions are too low because of an incorrect compensation definition, the employer is usually responsible for funding the missed contributions, including missed employee deferrals. If too much has been contributed, employers should remove the excess amounts from the participant's account.
Contributions
Mistake: The IRS sets annual contribution and compensation limits for employee benefit plans. Employee contributions are limited to $17,500 for 2013, but, if allowed for in the plan document, employees aged 50 or older can make catch-up contributions up to $5,500. In addition, for 2013, only the first $255,000 of compensation earned by an employee may be used to determine employer contributions. Employers need to be cognizant of excess contributions throughout the plan year.
For example, suppose John, aged 54, earns $300,000 in plan compensation for 2013, and elects to contribute the maximum allowable of $17, 500, plus $5,500 as a catch-up contribution, for total allowable contributions of $23,000. Also suppose the employer match is 5 percent, which results in maximum employer contributions of $12,750 ($255,000 x 5 percent). Any erroneous contributions above these allowable amounts are considered excess contributions and should be flagged for correction as early as possible.
The Fix: To prevent excess contributions, monitor contributions throughout the year and perform annual compliance testing at the end of a plan year. Failure to identify these errors in a timely manner may require employees to re-file their personal tax returns.
If employee contributions are overfunded, excess amounts should be refunded to the participant. If the overfunding relates to employer contributions, these amounts should not be returned directly to the employer because this could be construed as a prohibited transaction. Generally, these amounts are forfeited and placed in a suspense account within the plan. These amounts can then be used for certain plan purposes, as defined in the plan document.
If employee contributions are underfunded, the IRS's correction programs require the plan sponsor to make a corrective contribution equal to a minimum of 50 percent of the missed contributions, plus lost earnings. But, if the underfunding relates to employer contributions, the plan sponsor should contribute 100 percent of the missed contributions, plus lost earnings.
Eligibility
Mistake: Determining when an employee is eligible to participate in a retirement plan can create inadvertent errors. Many plans have eligibility requirements related to an employee's age and years of service, as well as specific plan entry dates. Some plans elect to exclude certain classes of employees, such as per diem or part-time employees. But what happens when an employee changes from an ineligible class to an eligible class or vice versa? In these cases an employee could be eligible immediately or for only part of a year.
The Fix: Regular monitoring of the service requirements and changes in employee status can help prevent errors.
Distributions
Mistake: The recent economy has caused more requests for hardship withdrawals and participant loans. Many plan sponsors will approve the requests, not realizing their plan documents either entirely prohibit them or don't allow them to be taken from specific sources (for example, only employee contribution accumulations, and not employer contribution accumulations). Plans that do allow for hardship withdrawals often require a freeze on employee contributions for six to 12 months after a hardship withdrawal.
The Fix: Plan sponsors must stop employee contributions following a hardship withdrawal, as any contributions made during the required freeze period are impermissible and should be treated as excess contributions. Most plans also require all other forms of distribution, including participant loans, to be taken prior to hardship withdrawals. And some plans allow more than one loan outstanding at a time. In such cases, employees are required to take multiple loans before they can take a hardship withdrawal.
Depositing Employee Contributions
Mistake: The Department of Labor (DOL) requires plan sponsors to remit employee contributions to the plan as soon as reasonably practicable. Essentially, this means an employer should remit employee contributions as soon as it can reasonably segregate these funds from its general assets. This could be two days for one employer or five for another. Informal guidance suggests that for large plans, employee contributions should be deposited within three to five business days.
The Fix: While the wording may be vague, in no event can this remittance be more than 15 business days into the month following the withholding month, or this would be a prohibited transaction, which must be reported to the DOL. But don't rely on the 15-day rule-a deposit that is not made as soon as reasonably practicable, even within 15 business days, can be considered a prohibited transaction. If there are late deposits, a plan sponsor is generally required to contribute lost earnings to participants' accounts, or be subject to DOL fines or penalties.
Dot Your I's
Plan documents are complex, so it's not uncommon for a plan sponsor to misinterpret or incorrectly implement the provisions. The plan sponsor is responsible for making the plan and/or plan participants whole, so if you have any doubts, seek professional guidance to clarify or confirm your understanding of your plan document.
Errors may occur because the plan document does not reflect the intentions of the plan sponsor. These errors often happen during plan amendments and complete document restatements (as with a change in service providers) when an improper box is checked on the adoption agreement or a plan specification is ambiguous. The contribution cost you're trying to save by electing certain provisions can be lost if it results in corrective contributions or fines. To avoid this error keep your plan document provisions simple.
Once you identify a mistake, it's important to determine how long it has been happening and how many employees are affected. You should also consider engaging the help of a retirement plan professional to untangle the situation and determine the best course of action.
Sandra Pappajohn is a manager in BerryDunn's Diversified Commercial Group, which provides audit, accounting, and consulting services to clients throughout New England. For more information, visit berrydunn.com or contact her directly at spappajohn@berrydunn.com.
Current Issue - April 2024