Be Wary of the Pitfalls of Retirement Plan Administration  – They Be Costly to Your Company

Oct. 15 is  upon us. For some, this is just another day on the calendar. For those responsible for an employee-benefit plan, however, this is a very important date.

Oct. 15 is the extended due date for filing a calendar year-end employee-benefit-plan tax return — Form 5500. This means that many of you are wrapping up your annual financial statement audit, or are working with your third-party administrator to remember your PIN and password, which is needed to electronically file your return.

As an auditor of these plans, I often see fiduciaries who are not fully aware of the specific provisions of their plan or the rules and regulations regarding their retirement plan administration. As a result, there are many errors that can occur. Some of these errors can lead to serious consequences regarding the continuation and qualified status of the plan.

While preparing your plan’s tax filing, it’s a good idea to re-evaluate some of the process and controls involved, making adjustments and improvements where necessary.

This article is intended to highlight some of the more common errors that are found, including 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.

Timing of Employee Deferrals

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.

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 outside of the established guidelines, even if only by one day, may be considered late and consequently subject to corrective procedures and excise tax reporting.

Eligibility and Compensation

There are many items that are defined in the plan document. Two of the most misunderstood and/or overlooked definitions are those for plan eligibility and compensation.

Misunderstanding the plan’s definition of ‘eligibility’ often leads to employees being delayed entrance to a plan when they are eligible, while other employees are allowed to enter the plan prematurely. Many administrators misinterpret the difference between when an employee meets the eligibility requirements and when the employee is allowed to enter the plan. For example, if an employee meets the eligibility requirements of a plan on June 1 but 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 performed properly, please check with your third-party administrator or CPA, as the penalties for failing to comply with the provisions of a plan can be severe.

Compensation is another area to which plan administrators need to pay particular attention. First, not every plan uses the same definition of compensation. Second, the plan may use different definitions of compensation for different purposes, such as for deferrals and employer contributions. Most often overlooked 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 not, a written election from the employee must be on file.

Hardship Distributions

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 provide 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 block foreclosure proceedings of 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 provide 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. 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.

Third-party Administrators

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 minimum, those assigned to oversee the plan obtain and review the reports that are available from the third-party administrator on 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 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?

By Jim Krupienski, CPA