Many things can go amiss in the administration of a 401(k) plan – here are three common errors as told by employee benefit plan auditors.
Incorrect Definition of Eligible Compensation
According to a blog post by Kriste DeAngelo and Robert Reilly of EisnerAmper LLP, one of the most common plan errors they see is the failure to use the correct definition of compensation to calculate participant deferrals and employer contributions. They note that each plan’s definition of compensation should be clearly defined in the plan document, but that often that document is not read, or reviewed when new payroll codes are implemented, and eligible compensation that was initially set up correctly is no longer calculated in accordance with the plan document. They note that it is crucial to review the plan document, particularly when there is a change in personnel or payroll provider or when new types of compensation are added to the payroll system.
Late Participant Deferrals
They note that employee contributions that are withheld from participants’ pay must generally be remitted to the plan on the earliest date that those contributions can be reasonably segregated from the employer’s general assets, though it cannot be later than the 15th business day of the month following the month the participant contributions were withheld. As for what constitutes a reasonable timeframe, they note that most employers routinely submit payroll taxes withheld from employee paychecks as soon as one to two business days, or even the same day, as the date of payroll, and that the Labor Department often takes the position that if the payroll taxes can be remitted in that timeframe, so should retirement plan contributions. That’s important because late remittances are considered prohibited transactions that must be corrected and reported on both the Form 5500 and the plan’s financial statements, not to mention the need to calculate and fund lost investment earnings on the late remittances in order to make the participant’s accounts whole.
Hardship Distributions Not Administered Properly
Many plans allow for hardship distributions, whereby participants can receive distributions because of immediate and heavy financial needs.
Hardship distributions must be limited to cover immediate and heavy financial needs, and the employee must not be able to reasonably obtain the funds from another source. While the plan document will define what is considered an immediate and heavy financial need, as well as any other requirements related to hardship withdrawals, the authors note that they have seen where hardship distributions were paid to participants who did not qualify, either because there was not a documented financial need or because the participant did not first take out a plan loan. In addition, many plans have provisions where a participant cannot make contributions for a certain period of time after receiving a hardship distribution, typically for six months. Administering this provision can be challenging (and easily be overlooked) if the plan administrator is not completely familiar with the plan document. They suggest a formal approval process for hardship distributions, including obtaining documentation of the hardship reason, certification of the unavailability of alternative funding sources, and a procedure to assure employee contributions cease, if applicable.
In addition to those three, they note that other common noncompliance areas are failure to:
- follow the provisions surrounding loan defaults;
- increase deferral percentages annually when there is an escalation provision in the auto enrollment feature; and
- include part-time employees in the plan when the plan document does not exclude them.
As for recommendations to forestall these problems, they offer two suggestions:
- Implement a strong internal control system around plan operations, along with a set of plan-specific procedural checklists (contribution calculators, contribution deposit calendars and hardship withdrawal approvals).
- All parties responsible for administering should regularly review the plan document.