Your plan year has come to a close and you’ve decided to perform your annual plan review so that nothing will surprise you when the annual audit rolls around. As part of the process you review the payroll records, trust deposit statements and the plan document.
- Based on records from payroll, employee elective deferrals were withheld from each weekly payroll.
- The trust deposit statements show that employee elective deferrals that were withheld from pay during a month were deposited within 3 business days of the final pay date of the month.
- The plan document says employee deferrals are to be deposited within 3 business days of each pay date.
Because your company has more than one payroll during a month and delays depositing deferrals until after the final pay date each month, the deferrals taken for the earlier payrolls each month were not deposited within the time limit required by the plan document (within 3 business days of the pay date). Now what happens?
The Internal Revenue Service (“IRS”) and the Department of Labor (“DOL”) focus on different rules regarding how quickly employers must contribute participant deferrals to the plan’s trust account.
DOL Requires Deposit to be Made Immediately After the Contributions Can Be Segregated
Regardless of any other timing requirement specified in the plan document, the DOL rules require that the employer deposit deferrals to the trust as soon as the contributions can be “reasonably” segregated from the employer’s general assets. Generally, the DOL requires deferrals to be deposited the day of, or at most a day or two after, the pay date. The one exception to this deposit timing rule is the DOL safe harbor established for small employer plans (i.e., plans with fewer than 100 participants) which allows deposits to be made within 7 business days of the pay date. In no event can the deposit be later than the 15th business day of the following month. However, this 15th business day maximum is not a safe harbor for depositing deferrals. There are almost no circumstances under which the DOL would accept this maximum time period as being “reasonable.”
In the above example, by depositing the deferrals within 3 business days of the final pay date of each month, the employer has demonstrated that it can reasonably segregate deferrals from general assets and deposit them within 3 business days after a pay date. This means that the employer would violate the DOL timing requirement for the earlier pay dates in the month by delaying the deposit until after the last pay date. Also, if the employer sometimes makes the deposits for the final pay date within only 2 days following the pay date, the DOL could find that an even stricter standard is “reasonable” for the employer, causing any deposit made more than 2 days following a pay date to violate the DOL rules.
If the employer does not deposit deferrals to the trust by the DOL deadline, a “prohibited transaction” occurs. This means that the DOL treats the late deposit as an impermissible loan from the plan to the employer that must be corrected, as described below.
IRS Requires Deposit Timing to be Consistent with the Plan Terms
Although it isn’t common, some plan documents contain a specific time for deposits (as provided in the above example). If your plan document contains language about the timing of deferral deposits (i.e., within 3 business days of each pay date), any deposit made later than the date required by the plan terms causes an operational failure. The failure to follow the plan terms regarding the timing of deferral deposits can lead to plan disqualification unless you correct this operational failure under the IRS correction program known as “EPCRS,” as described below.
How to find the mistake:
Review plan terms relating to the deposit of elective deferrals and determine if you’ve followed them. If the deposit was made later than the plan terms allow, the IRS rules have been violated.
Review past deposit records to determine the number of days between each pay date and its corresponding deposit date. If you find deposits are routinely made within 1 or 2 days, it is likely that the DOL would determine deposits made no more than 2 days after the pay date are acceptable under the DOL deposit rules, but any deposits made more than 2 days after the pay date are late (even if the plan terms provide that deposits may be made within 3 days after the pay date).
How to fix the mistake:
Corrective Action – DOL:
Correction through the DOL Voluntary Fiduciary Correction Program (“VFCP”) may be required if the DOL deposit timing rules were violated. Correction under VFCP for late deposits may require you to:
- Determine which deposits were late and calculate the lost earnings from when the deferrals should have been deposited to when they were deposited (as may also be required under EPCRS).
- Deposit any missed elective deferrals, together with lost earnings, into the trust (as may also be required under EPCRS).
- File Form 5330 with the IRS to pay an excise tax on the prohibited transaction (generally 15% of the lost earnings, with a complicated pyramiding calculation because late deposits for a plan year are considered as re-occurring each subsequent January 1 until they are fully corrected).
- Submit a VFCP application and supporting documentation to the DOL for its review and approval.
- Report the delinquency in making deposits on Form 5500 for each year until the error has been fully corrected.
Corrective Action – IRS:
Correction through the IRS Employee Plans Compliance Resolution System (“EPCRS”) may be required if the terms of the plan weren’t followed. EPCRS offers three programs (the Self-Correction Program (“SCP”), the Voluntary Correction Program (“VCP”), and the Audit Closing Agreement Program (“Audit “CAP”)) for correcting plan errors, depending on the type of error, when the error is discovered and corrected, and whether the error is considered to be significant. Regardless of which program applies, correction for late deposits may require you to:
- Determine which deposits were late and calculate the lost earnings from when the deferrals should have been deposited to when they were deposited.
- Deposit any missed elective deferrals, together with lost earnings, into the trust.
- Review procedures and correct deficiencies that led to the late deposits.
How to avoid the mistake:
- Establish a procedure requiring elective deferrals to be deposited coincident with or as soon as administratively possible after each pay date. Plan ahead to avoid late deposits caused by vacations or other disruptions. However, if minor unavoidable delays occur, keep a record of why those deposits were late (realizing that the DOL could still require corrective action for violating the DOL timing rules).
- Coordinate with your payroll provider and others who provide service to your plan, if any, to determine the earliest date you can reasonably make deferral deposits. The date and related deposit procedures should match your plan document provisions, if any, about this issue.
- Implement practices and procedures that you explain to new personnel, as turnover occurs, to ensure that they know when deposits must be made.
Offering a 401(k) retirement plan for your employees is a wonderful benefit for them. Avoid allowing plan administration to become a headache for you by implementing internal controls that ensure timely deposits of deferrals.