The Importance of On-Time Deposits of your 401k Contributions
WHY 401k CONTRIBUTIONS ON TIME MATTER
Late 401(k) deposits are high priority enforcement matters with the Internal Revenue Service (IRS) which oversees the tax aspects and the Department of Labor (DOL) which oversees the fiduciary aspects of your company’s retirement plan. Plan sponsors have a fiduciary responsibility to make sure these deposits are made as soon as possible. However, there may be times when staff shortages, vacations or some other problems cause a plan sponsor to be late. How you address this issue depends on how serious the problem is.
“If one or two payroll cycles were late with deposits, or the plan sponsor missed deposits for a handful of participants, generally, the employer would simply self-correct that issue by depositing the contributions and figuring out the lost earnings caused by the money not being invested in the 401(k) plan,” said Bruce Ashton, a partner in the employee benefits and executive compensation practice of law firm Drinker Biddle & Reath LLP in Los Angeles. “In this case there is no need to file the paperwork with the DOL or with the IRS. Plan sponsors just need to keep records of what they have done.”
Employers whose plans have fewer than 100 participants must ensure that their payroll vendor (if payroll is done externally) or their internal payroll department deposits all employee contributions and plan loan repayments by the seventh business day after the paycheck from which those amounts were withheld is issued.
Employers whose plans have 100 or more participants must ensure that all employee contributions and plan loan repayments are deposited by the earlier of (1) the date those contributions or loan repayments reasonably can be segregated from employer assets, or (2) the 15th business day of the month after the paycheck was issued.
The responsibility for ensuring these timely deposits rests solely with the employer as plan sponsor and plan fiduciary. Although some 401(k) plan vendors may send reminders if they do not receive plan deposits on the expected date, those vendors are careful to limit their involvement in order to avoid assuming any fiduciary responsibility for making these deposits.
In itself, a late deposit is not a catastrophic event. The problems begin when this lateness is chronic, not remedied, fraudulent in nature, or some combination of these.
FIXING THE SITUATION
Once plan sponsors realize that a deposit is late, they must take steps to fix the situation, including making the deposit as soon as possible and adding any lost earnings on those deposits resulting from the late deposit. The U.S. Department of Labor’s Voluntary Fiduciary Correction Program includes a penalty calculator, and the IRS offers these guidelines for addressing the situation.
If the problem persists and more deposits are made late or not at all, the plan sponsor could be considered to be in control of those 401(k) plan assets, said Rich Rausser, senior vice president of client services at Pentegra Retirement Services in White Plains, N.Y. Alternatively, the late deposits may be considered a loan of plan assets to the plan sponsor. Both of these circumstances are prohibited transactions under the Employee Retirement Income Security Act (ERISA) and are subject to an excise tax, Rausser explained.
Moreover, if the problem goes on for some time and the plan sponsor does not report or address it using the self-reporting mechanism, employees or some other whistle-blower may report the plan sponsor for this violation. If the plan is audited as a result, the penalties for that breach will be far greater than they would have been if the plan sponsor had reported and addressed the issue.
If a company is found to have engaged in a prohibited transaction under ERISA because of late contribution deposits, it could face an excise tax on the amount of earnings participants lose because their contributions have not been deposited or invested. For example, Ashton said that if a $1,000 deposit is late and plan participants lose out on $100 in earnings because of that delay, the prohibited transaction excise tax would be 15 percent of $100.
In some cases employers can avoid paying the excise tax by notifying workers of the late deposit and what has been done to correct the situation. However, “Many employers don’t want to send that type of notice to their employees, so they go ahead and pay the excise tax, in addition to making the late deposit and making up the lost earnings,” said Ashton. In this case plan sponsors can send their own notice, giving them more freedom to frame the issue than they would have if they had to follow the DOL’s notice requirements.
TRIGGERING A PLAN AUDIT
Late deposits, especially as part of an ongoing pattern, could trigger a plan audit by the DOL or the IRS. When filing the annual Form 5500, the plan sponsor must report whether the plan has been late with any of its deposits, even if those deposits have since been corrected.
If the Form 5500 reporting draws a DOL inquiry, the plan sponsor can respond with an explanation of what happened and what it did to correct the issue. If the failure is ongoing and egregious and the DOL determines that the plan sponsor did not handle the situation appropriately, the agency may launch a more thorough investigation. In these instances the DOL has the authority to add another 20 percent penalty on top of any lost earnings and excise taxes.
In any of these cases, an admission of late deposits could lead to a plan audit by the DOL. “One of the first things that the Department of Labor looks at when they do an audit is company payroll records, in order to verify that 401(k) plan deposits were made in a timely way,” said Mickie Murphy, a director at accounting firm CliftonLarsonAllen LLP in Joliet, Ill. “In an audit circumstance they are going to look at the earliest possible date the plan sponsor could have made the deposit, often using the timing of payroll tax deposits as a guideline. Loan payments from participants are in the same category as contributions and must be deposited accordingly.”
Because these issues are complex, you should consult legal counsel before taking action.