When IRS and DOL officials are asked to identify the most frequent compliance failures on the part of 401(k) and 403(b) plan sponsors, the late deposit of employee deferrals is consistently at the top of the list.
Under ERISA, amounts deducted from participants' paychecks become plan assets as of the earliest date on which such contributions can reasonably be segregated from the employer's general assets. A number of years ago, the DOL issued confusing guidance that referred to an outside plan deposit date of the 15th business day of the month following the month in which amounts were deducted from participants' paychecks. However, in subsequent guidance, the DOL has clarified and aggressively taken the position that "earliest date" typically means several days after amounts are deducted from each paycheck.
There is a specific question on the 5500-SF return that small employers are required to file each year and on the Schedule H that is part of the 5500 filing package for large plans that asks if deposits were made on time. Failure to respond to that question truthfully could be considered a fraudulent act on the part of the plan sponsor.
Small Plan Safe Harbor: If eligible, take advantage of the DOL's contribution safe harbor for small plans. Under the safe harbor, the DOL considers deposits to be timely if they are deposited into the plan within 7 business days from the date they are deducted from participants' pay. This safe harbor is available only to "small plans" which are defined to be plans covering fewer than 100 participants.
Large Plans Need to Be Even More Timely: There is no contribution safe harbor available to large plans covering 100 or more participants. Instead, the DOL states that elective deferrals must be deposited "as soon as administratively feasible." In the past, this "fuzzy standard" has resulted in uncertainty on the part of large plan sponsors as to what degree of timeliness is actually required to avoid being sanctioned. In public statements, DOL officials have fairly consistently taken the position that large employers should be able to deposit elective deferrals within two to three business days following the date they are deducted from participants' paychecks-- unless there are extenuating circumstances. Accordingly, this should be the target for large plans if it is possible to meet it consistently.
Avoiding Late Deposits
Here are a few tips on how to avoid late deposits.
Be Consistent: If the plan qualifies for the small plan safe harbor, be sure to consistently meet the seven business day standard throughout the year. If you are responsible for making deposits for a large plan, attempt to establish a process that will result in deposits being made within approximately the same time frame following each pay date. Occasionally depositing deferrals the day after pay dates can actually work to the employer's detriment if that isn't the normal routine. The DOL can take the position (and has) that if the employer can deposit contributions within one or two days some of the time, it should be able to do so all of the time.
Implement Electronic Interfaces: The best way to assure consistent timeliness is to link the employer, the employer's payroll vendor, and the 401(k) recordkeeper/platform provider to one another electronically. When this happens, elective deferral contributions can be automatically deducted from the corporate checking account and wired to the custodian/financial institution where the plan funds are invested, and a contribution file can be sent electronically to the plan's recordkeeper showing the amount of contributions (and loan repayments, if applicable) to be allocated to each participants' account. Once the process has been established, contribution processing can occur routinely with little or no direct involvement on the part of the employer's internal payroll person. Note: In some processing routines, the employer is engaged each pay date to the extent of "pushing" the funds to the custodian/financial institution whereas, in other instances, the employer pre-approves having funds pulled from the business checking account automatically.
Education/Backup: It is extremely important that the individuals responsible internally for administering the employer's payroll and 401(k) contribution processing be aware of the time standards for 401(k) contribution processing and the importance of consistently adhering to them. The plan sponsor's internal payroll person may be responsible for both payroll processing and 401(k) contribution processing, but that is not always the case. Errors and omissions tend to occur more frequently when there is a change in personnel or when a different individual assumes temporary responsibility while the person who is typically responsible is on vacation or leave of absence. It is important that a backup person be assigned in advance and be aware of the process and time table.
Review Deposits Each Pay Date: Implement a process to check every payroll after it has been submitted for obvious errors and to confirm that each contribution has been received by the plan's designated financial institution and allocated to participants' accounts on time. This not only helps avoid late deposits, but can also detect very early in the process if deferrals were in fact deposited outside of the appropriate timeframe.
Addressing Late Deposits
When a determination is made that deposits are late, the DOL requires the employer to reimburse the plan for lost investment returns for the periods of time that the funds were not in the plan. An employer's failure to deposit employee elective deferrals on time is also a prohibited transaction under ERISA and the Internal Revenue Code. Accordingly, this compliance failure typically results in the imposition of monetary penalties by the IRS.
The full correction of late deposits involves a number of complex steps:
Deposit all late or missing participant withholdings
Deposit and allocate lost earnings to plan participants
Report the violation on Form 5500
File Form 5330 and pay an excise tax to the IRS equal to 15% of the lost earnings
Submit for formal correction through the DOL-sponsored Voluntary Fiduciary Correction Program
Although the lost earnings and excise tax are often nominal, the work effort behind these correction steps can be quite costly to plan sponsors. And, even though the violation may seem minor, we can assure you that the IRS and DOL view this as a serious matter. As the number one violation of retirement plans, they target this matter in any audits or investigations.
ABP’s year-end questionnaire includes an inquiry on the timeliness of deferral deposits. Also, if we notice late deposits during the course of plan administration, we will bring them to your attention. But if you are aware that you made late deposits, the best practice is to notify ABP as soon as possible. ABP can help verify, document and correct any issues, as well as provide guidance on processes to avoid any future late deposits. Addressing this type of problem sooner rather than later is always better.
Both payroll and 401(k) contribution processing are transaction-intensive, and both require the interaction of multiple individuals and entities. Errors and omissions can happen even when the best processes are in place. Don’t be afraid to admit that there has been an error. ABP will discuss your correction options and will help get your plan back into compliance. Most importantly, your prompt self-correction of these issues will help prevent any significant ramifications from the IRS and DOL.