As a professional who assists in conducting hundreds of employee benefit plan audits each year, I have seen everything and heard so many lame excuses for the errors that we find. Some infractions range from plans allowing participation to ineligible participants, to not allowing eligible participants to participate timely, or even at all. Although the list of mistakes plan sponsors make is a long one, there are three common errors noted during our audits:
No. 1: Incorrect definition of compensation.
This is by far the most common error we discover, and the one that causes plan sponsors the most headaches when correcting. The main reason for the error is easy: Plan managers never read the plan document to ensure that when contributions are made, the proper definition of compensation is used in the calculation. Even if a plan sponsor does read the document initially, few rarely read it again, and the breakdown occurs at a later date.
As we all know, there are many types of compensation that may be included in the definition of compensation as defined by the plan, such as straight time, base pay, overtime, vacation pay, bonuses, commissions, auto allowances, fringe benefits and so on, and many of those types of compensation may be excluded from the definition.
To further complicate this issue, there may be different definitions of compensation with respect to employee deferrals and employer match contributions. In fact, there could even be another definition if there is a profit-sharing contribution in the plan. Knowing the correct definition of compensation is essential to ensure that the plan is operating in compliance with the governing documents.
When a plan is not operated in accordance with the plan document (like contributing deferrals on the wrong compensation, as defined in the plan document), it is referred to as an "operational defect." Operational defects can affect a plan's tax-qualified status and must be corrected by making the participants whole. This means an employer must put in the money that the participant would have put in, if the compensation used was the correct amount according to the plan.
The best way to avoid such a problem is to know your plan document and to refer to it on a regular basis. If you are unsure, don't guess. Vigilant attention is a must, and plan sponsors should pay particular attention to this on an ongoing basis.
No. 2: Failure to follow the plan's eligibility provisions.
There are four basic errors that we generally find surrounding eligibility:
1. Allowing participants in the plan that are excluded per the plan provisions.
2. Allowing eligible participants into the plan prior to meeting the eligibility requirements.
3. Not allowing eligible participants into the plan on a timely basis.
4. Not following the eligibility provisions with regard to the elective deferrals and the employer match or profit-sharing contributions.
Similar to the different definitions of compensation as described in No. 1, there also could be different eligibility requirements for when an employee can make an elective deferral and when they will receive an employer match. Often, eligibility for an elective deferral may be immediate or may have a certain service requirement, but to receive an employer match, the service requirement may be longer or the participant may have to be employed on the last day of the plan year in order to be eligible for a profit-sharing contribution.
To avoid an error surrounding eligibility, be familiar with the plan provisions and identify who determines eligibility. Is it the plan sponsor or a third-party provider? Either way, plan sponsors should monitor the process and periodically perform a self audit to ensure that the process is working properly and the provisions are being followed in accordance with the plan document.
No. 3: Late deposits of employee deferrals and loan payments.
As we all know, employee deferrals and loan payments must be deposited into the plan as soon as administratively possible, but no later than the 15th business day of the month following the month in which the participants' contributions are withheld by the employer.
However, a big misconception is that the 15 days is a safe harbor. People focus on the number 15 and not the "as soon as administratively possible." There is no safe harbor for large plans; recently, however, the Department of Labor issued a safe-harbor rule for small plans with less than 100 participants, which is seven business days from the date withheld.
Therefore, one would expect that a large plan should be more sophisticated with more resources, so the number of days should be less than the seven-day safe harbor for small plans.
I have heard several DOL representatives use the payment of payroll taxes as a comparison of the time period in which the deferrals and loan payments should be deposited into the plan. If, for example, payroll taxes can be paid within three days, then one could argue that employee deferrals and loan payments could be deposited into the plan within that time frame as well.
This is a sensitive subject, because we spend a great deal of time with frustrated clients who have to correct these errors, and at times it is very costly for them. They wish they were more on top of the plan's day-to-day operation so such situations could be avoided. I cannot urge plan sponsors enough that careful and diligent attention to the provisions of a plan is a must to ensure it is being operated properly and in compliance with the plan document.
Kriste Naples-Deangelo is a partner in the pension services group at EisnerAmper LLP, responsible for managing numerous employee benefit plan audits. She has more than 25 years of experience in public accounting.
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