Retirement-plan Administration – Take Needed Steps to Avoid What Can Be Very Costly Pitfalls

July 31 is fast approaching. For some, this is another day on the calendar. For those practices with an employee-benefit plan, this is a very important date. July 31 is the due date for filing a calendar year-end employee-benefit-plan tax return — Form 5500. This means many of you are just now entrenched in your annual financial statement audit, or are working with your third-party administrator to gather and review all required filing information.

As auditors of these plans, we see oftentimes that the plan fiduciaries are not fully aware of the specific provisions of their plan, as well as all of the rules and regulations regarding proper administration. As a result, there are many errors that can occur, some of which could lead to serious consequences regarding the continuation and qualified status of the plan. While your plan’s tax filing is currently at the top of your to-do list, it is a good time to look at some of the areas where processes can be improved and operating controls cleaned up.

This article is intended to highlight some of the more common errors that are found, such as the timing and remittance of employee-deferral contributions, the improper application of the definitions of eligibility and compensation, the improper use and review of hardship distributions, and a general overreliance on the plan’s third-party administrator.

Employee-deferral contributions are required to be remitted to the plan as soon as they can be segregated from the company’s general assets, but in no event later than the 15th business day of the month following the month they were withheld. In many instances, plan administrators will cite the 15-day rule when discussing their remittance policies. It should be noted that the 15-day rule is not a safe harbor, but rather the last day before contributions are automatically considered late.

Note that there is a seven-day safe harbor for certain eligible small plans; however, large plans are held to a different standard. More often than not, upon examination by the Department of Labor, examiners will look at when all other payroll taxes were remitted by the company. In addition, they will look at consistency, adherence to the established policy, if any, and past history. With technology today, most plans should be able to remit these funds within three to seven business days. Any remittances that fall out of the established guidelines, even if by only one day, may be considered late and, consequently, subject to corrective procedures and excise-tax reporting.

Many items are defined within the plan document. Two of the most misunderstood or overlooked definitions are those for plan eligibility and compensation. In terms of plan eligibility, many times eligible employees are delayed from entering the plan, and other employees are allowed to enter the plan too soon. Many administrators misinterpret the differences between when an employee meets the eligibility requirements versus when the employee is allowed to enter the plan.

As an example, if an employee meets the eligibility requirements on June 1 and there is a quarterly entrance date, the employee may not be able to enter the plan until July 1. If for any reason you feel that this is not being properly adhered to, check with your third-party administrator or CPA, as the penalties for failure to comply with these provisions of the plan can be severe.

Compensation is another area in which plan administrators need to pay particular attention. First, every plan does not use the same definition of ‘compensation.’ Second, the plan may use different definitions of compensation for different purposes, such as for deferrals and employer contributions. Additionally, the most-often-overlooked item within the definition of compensation is the treatment of bonus compensation in relation to the plan definition of ‘eligible compensation.’

For example, if the plan elects to use W-2 wages as its definition of compensation, all bonuses, whether through payroll or manual check, must be included when calculating the employee deferrals. If there is no deferral on bonuses, but they are part of plan compensation, a written election from the employee must be on file.

With the current economic conditions, hardship distributions may become more common for those plans that allow them. It is critical to take note of the rules and regulations for these distributions, which must be adhered to. First, before a hardship distribution can be requested, the employee must evidence to the employer that all other sources of financing, including loans from the retirement plan, have been exhausted. Second, the amount requested cannot exceed the amount needed to satisfy the event at hand, such as the amount necessary to preclude foreclosure proceedings or eviction from a home. Additionally, the request can be made only to satisfy certain predetermined obligations. Purchasing a new car is not a qualifying event. In order to evidence that these provisions have been met, it is strongly recommended that the request be made in writing and that the employee provide documentation that should be kept on file with the application.

Such evidence to verify eligibility is ultimately the responsibility of the plan sponsor. Finally, once the distribution has been made, it is imperative to understand that employee deferrals to the plan must be suspended for a period of six months.

When errors are detected, the response most often heard is, ‘why didn’t our third-party administrator catch this?’ Unfortunately, while this may be a valid argument in some cases, at the end of the day there is a fiduciary responsibility that has been placed on the trustees and administrators who oversee the plan in-house. Adequate time and attention are often not devoted to administering these plans, but when something goes wrong, there is the potential for personal liability, up to and including fines and other penalties.

It is recommended that, at a minimum, those assigned to oversee the plan obtain and review the reports that are available from the third-party administrator on at least a quarterly basis. When reviewing these reports, don’t focus solely on investment performance. Take the review further. Tie out contributions posted to the account to your general ledger and payroll records. Review loan activity and balances, questioning new loans that aren’t recognized, or outstanding loans with balances that have not changed. Also, review benefit payments to ensure that you have properly executed withdrawal request forms on file for each.

Retirement plans, depending on how they are designed, can be very complex. Additionally, there are many rules and regulations that need to be followed, which are not always spelled out explicitly in the plan document. Penalties and ramifications for not following the plan document or governing rules can be extremely severe.

It is strongly recommended that your plan, no matter how large or small, have a few basic controls and procedures in place. Your CPA or third party administrator can assist you with this process, but they can’t replace the ultimate responsibility that you have as the plan’s fiduciary.  In the event of an unwanted knock on the door from the Internal Revenue Service or Department of Labor, how well-prepared will you be?