Perspective: Sweaty Palms and Constricted Throats (part 2)

When the IRS points out retirement plan mistakes, avoid the ‘flight or fight’ urge

This column is the second installment of a two-part series on common mistakes by 401(k) plans.  

Having someone point out a mistake we’ve made can sometimes cause an emotional reaction, from slight annoyance to intense wrath. But when that “someone” is the Internal Revenue Service (IRS), our natural “fight or flight” instincts can take over and our reaction can be downright ugly.

Without fear of reprisal, the IRS regularly publishes its list of the top mistakes committed by 401(k) plan sponsors.  But instead of fighting or fleeing, employers are urged to take heed. These mistakes should be viewed as opportunities to improve existing retirement plans for the benefit of both employees and employers.

In the last column, I addressed the top five mistakes made by retirement plan sponsors as identified by the IRS: failure to update plan documents, failure to follow terms of the plan; incorrect application of the plan’s definition of compensation for deferrals and allocations; misapplication of employer matching contributions to eligible employees; and the failure of 401(k) plans to satisfy nondiscrimination tests (read that column here).

(6) The rest of the list starts with mistake number six, when the IRS asks if all eligible employees have been identified and given the opportunity to defer income. Before your clients have to reply, make sure they monitor their retirement plan’s census information and allow newly eligible employees to participate within the time frame required by the plan.

(7) As part of mistake seven, the IRS asks if elective deferrals were limited to the amounts specified by IRC Section 402(g) for the calendar year ($16,500 for 2009 as well as 2010). Have any excess deferrals been distributed? Again, the IRS urges employers to work with their plan administrator to ensure they have sufficient payroll information to verify that the requirements are met.

(8) Failing to deposit employee elective deferrals on a timely basis is mistake eight on the hit parade. Make sure your clients closely coordinate with their payroll provider to determine the earliest date that deferrals can “reasonably be segregated from general assets.” Procedures should be established to ensure deposits are made by that date. Typically, that takes place within three to five business days from the date the money is withheld from employee wages but smaller plans have as “safe harbor” that allows them as many as seven days.

(9) Mistake number nine is not making required minimum contributions to “top heavy” plans. The IRS recommends performing a top-heavy test each year.

(10) Another common mistake – coming in at number 10 – is making improper hardship distributions. This can be avoided by employers becoming familiar with the hardship provisions in their plan and then following them. Employers are advised by the IRS to ensure that plan administrators and payroll offices share information regarding hardship distributions.

In any other industry, we’d stop at 10. But the 11th most common mistake identified by the IRS is not filing Form 5500 and not distributing a Summary Annual Report (SAR) to all plan participants annually. Plan sponsors should understand the filing requirements and not assume someone is filing this tax form on their behalf, or distributing the SAR on their behalf. More information is available from the 401(k) Resource Guide – Plan Sponsors – Filing Requirements, which can be found at

No one likes to have their mistakes pointed out, let alone 11 of them. But the exercise undertaken by the IRS to make these mistakes more widely known, if taken within the appropriate context, can be extraordinarily helpful to plan sponsors and their participants. And it gives financial advisers with an excellent opportunity to provide real value to their clients by helping to keep them out of the IRS doghouse.

E. Thomas Foster Jr., Esq., is The Hartford’s national spokesperson for qualified retirement plans. Foster works directly with broker/dealer firms and advisers to help them build their qualified retirement plan business and educate them about industry issues.

This information is written in connection with the promotion or marketing of the matter(s) addressed in this material. This information cannot be used or relied upon for the purpose of avoiding IRS penalties. This material is not intended to provide tax, accounting or legal advice. As with all matters of a tax or legal nature, you should consult your own tax or legal counsel for advice.