Inadvertent errors that 401(k) plan sponsors make are “ubiquitous,” says Natascha George, a partner in the ERISA and Executive Compensation Group at Goodwin Procter LLP in Boston.
“Qualified plans are very complex,” she says. “There are many rules, and they are technical.” In fact, she says, plan errors are so common that the IRS for the past two decades has developed formal procedures to help plan sponsors correct errors and avoid being disqualified from tax-exempt status.
While there are a number of errors that retirement plans can make, if sponsors work with their adviser, auditor and providers, they can avoid them, says Steven Bogner, managing director at HighTower Treasury Partners in New York. It is also important to hire a seasoned human resources (HR) director who has experience overseeing 401(k) plans, he says. The most successful way to avoid mistakes “is ensuring good communication among all of the parties” that are responsible for the plan—human resources, payroll, the retirement plan adviser, the recordkeeper, the accountant, the third-party administrator, providers and Employee Retirement Income Security Act (ERISA) attorneys, George says. “It’s a multidisciplinary process,” she says.
Service providers can be instrumental in discovering mistakes, agrees Fred Reish, chair of the Financial Services ERISA Practice at Drinker, Biddle and Reath in Los Angeles. “In my experience, advisers and plan sponsors are not usually the people who discover the errors,” he says. “Most errors tend to be discovered when there is a change in service providers, third-party administrators or recordkeepers, or through IRS audits. And, on occasion, we are referred into cases where a company is being acquired by another company, and the acquisition due diligence team discovers errors in the administration of plans. Even when advisers find errors, it is usually in connection with some kind of change.”
Most commonly, information is missing on their Form 5500 or audit report, Bogner says. “The Department of Labor can fine you $1,100 a day if you do not file a Form 5500 correctly,” warns Marcia Wagner, principal at The Wagner Law Group in Boston. In addition, Bogner says, “if there is a pattern of failing to transmit contributions on time, plans need to look into that. Plans also sometimes improperly exclude employees from making contributions.” If an employee earns a bonus, sponsors can also have difficulty calculating their compensation and the company match, George says.
“The other area where we are seeing operational errors in the administration of automatic enrollment features,” George says. “Is the plan deferring contributions at the right rate? If the plan document requires annual deferral increases, is the sponsor making them?
The plan could also “be in conflict with its investment policy statement (IPS),” Bogner says. Part of what we do as advisers, is review the IPS as part of our annual fiduciary review,” Bogner says, adding that “a good IPS will not be restrictive because you don’t want to box yourself in.”
The most common error that Wagner sees is “plan documents that aren’t updated.” This occurs because many sponsors use plan document prototypes from providers, she says. “Practically every prototype plan is not updated with all of the legal and regulatory changes,” she says. Sponsors can avoid this error by running the document by an ERISA lawyer to do a “gap analysis,” she says. “401(k) plans are not plug and play; they are complex and worthy of attention.”
Plans also frequently handle automatic enrollment, re-enrollment and auto escalation incorrectly, Wagner says. When an employer acquires a company and ends up with two 401(k) plans, they need to terminate one of the plans or integrate the two plans into one, she says.
When plans reach the size of at least 120 participants, they need to do a full audit, and they frequently overlook this, Bogner says.
Another common mistake, Reish says, is not passing the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test. This can be due to not correctly identifying highly compensated employees (HCE), excluding those who elect not to defer salary from the test, or not using the correct definition of compensation, he says.
Two other common errors found in 401(k) plans are not giving an eligible employee the opportunity to make elective contributions and failing to execute an employee’s salary deferral election, according to the IRS. In both cases, employers can use the IRS’ Employee Plans Compliance Resolution System to make a corrective contribution of 50% of the missed deferral for the affected employee.
Plans can also be in error if they allow a participant to exceed the IRS’ limits on deferrals, Reish says. For 2015, they are $18,000, with an additional $6,000 catch-up for those 50 and older. “The excess contributions over the IRS limit will need to be withdrawn by April 15 in the year following the year the excess occurred,” and if they contributions are not withdrawn by April 15, they “will be subject to double taxation—taxes in the year they were made and in the year distributed,” he says.
Then there is the problem of a plan permitting a participant to take out a hardship withdrawal that does not meet the specifications for a hardship withdrawal, Reish says. “The distribution should only be made on account of an immediate and heavy financial need and should only be for the amount necessary to satisfy that need,” he says. Companies tend to make mistakes with hardship withdrawals when they handle them directly, rather than having their provider do so, Bogner says. As for loans, many plans do not ensure that the money is paid back in a timely manner, Wagner says. Plans also need to ensure that they do not permit loans in excess of the $50,000 maximum allowed, Reish adds.
Plans also sometimes fail to start required minimum distributions, or the required beginning date (RBD), for those who have retired or have reached age 70 1/2, according to the IRS’ website.