Common 401(k) Plan Operational Deficiencies

Marilea Campomizzi, CPA and Erin Falk, CPAJune 7, 2016

AGENDASome of the common deficiencies or errors we will discuss include:

Ensuring your plan has been amended for changes in legislation

Timely remittance of employee deferrals and loan repayments

Making mandatory distributions in accordance with your plan document

Using the appropriate eligible compensation to calculate deferrals

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Internal Revenue Code (IRC) plan amendments

• Amendments to plan document to reflect change in the IRC

• Firm deadline of adoption is set by the Internal Revenue Service (IRS)

• Applies to all 401(k) plans with assets in the plan

• No exemption for terminating plans

PLAN AMENDMENTS

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Plan sponsor responsibilities:

• Prove timely adoption

Written plan document

Amendments reflecting tax law changes

PLAN AMENDMENTS

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Steps to determine if plan document has been amended in a timely fashion:1. Review the following documents:

Original plan document Plan amendments IRS opinion or advisory letters IRS determination letters Plan minutes

2. Determine type of written plan document Pre-approved plan Individually designed plan

3. Determine remedial amendment cycle Based on type of written plan document Last digit of plan Sponsor’s EIN

4. Review cumulative list of changes in retirement plan qualification requirements/reference lists Published by IRS annually

PLAN AMENDMENTS

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PLAN AMENDMENTSCumulative list of changes in retirement plan qualification requirements

Year Cumulative List Cycle Affected Plans

2015 Notice 2015-84 Cycle A Individually designed plans with an employer identification number ending in 1 or 6

2014 Notice 2014-77 Cycle E Individually designed plans with an employer identification number ending in 5 or 0 Governmental plans for which an election has been made

2013 Notice 2013-84 Cycle D Individually designed plans with an employer identification number ending in 4 or 9 Multiple employer plans

2012 Notice 2012-76 Cycle C Individually designed plans with an employer identification number ending in 3 or 8 Individually designed governmental plans that do not elect to file in Cycle E Pre-approved defined benefit plans

2011 Notice 2011-97 Cycle B Cycle B individually designed multiple employer plans Individually designed plans with an employer identification number ending in 2 or 7

*Example

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PLAN AMENDMENTSReference lists

• Tools to help ensure plan document incorporates all mandatory and optional changes in plan qualification requirements

• Found on IRS website

• Contains items that are new to the cumulative list for that year

• Fillable

*Example

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Corrective actions:

1. Adopt amendments for any law changes missed

IRS guidance provides sample amendments

2. File a Voluntary Correction Program (VCP) submission with the IRS

Fee for submission

Only use VCP if plan is not under examination

3. Correct under Audit Closing Agreement Program

Use if mistake is found during audit

Sanction fee is a percentage of the maximum payment amount

PLAN AMENDMENTS

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Tips to avoid the mistake:

• Review plan document annually

• Identify person responsible for adopting amendments in a timely fashion

• Keep all documents relevant and matching

Plan document

Summary plan description

Summary of material modifications

PLAN AMENDMENTS

POLLING QUESTION

TIMELY REMITTANCESTimely remittance of employee deferrals

• ERISA requires plan sponsors to remit employee deferrals to the Plan at the earliest date that such amounts (contributions and loan repayments) are able to be reasonably segregated from the employer’s general assets.

What is a “reasonable” time period?

TIMELY REMITTANCESFailure to make timely deposits

• Correction – deposit late contributions along with lost earnings

• Generally corrected through the DOL’s Voluntary Fiduciary Correction Program

• dol.gov/vfcpcalculator

TIMELY REMITTANCESHow to avoid the mistake

• Establish internal controls to ensure timely deposits• Coordinate with quality payroll provider• Implement practices and procedures with responsible

personnel

MANDATORY DISTRIBUTIONSScenario: Plan document includes provision to distribute a participant’s vested balance without the participant’s consent if the balance is less than $1,000 (often referred to as an involuntary cash-out). Plan administration has not been initiating these distributions and has not established a process with their service provider.

MANDATORY DISTRIBUTIONSMistake: Plan operations didn’t follow terms of the plan document.

How to fix: Correct as soon as possible by distributing balances that fall under your plan document’s threshold before identified by the DOL or IRS.

Example monetary sanction under IRS audit:

$30,000

MANDATORY DISTRIBUTIONSHow to avoid the mistake:

Review your plan document

• What does it say?

• Reference to timing? Immediate; periodically; as soon as administratively feasible?

Verify current plan operations in place

• Distributions initiated by plan sponsor or service provider

Make sure distributions are being handled consistently

MANDATORY DISTRIBUTIONSPlan document examples (1):

MANDATORY DISTRIBUTIONSPlan document examples (2):

MANDATORY DISTRIBUTIONSOther considerations: When a terminated employee doesn’t respond to communications regarding distribution options, and their account balance falls between $1,000 and $5,000, the plan administrator must establish a traditional IRA where the balance can be rolled over. The balance cannot be distributed to the terminated employee as cash.

POLLING QUESTION

ELIGIBLE COMPENSATIONScenario: Plan document’s definition of eligible compensation shows bonus amounts should be excluded. Historically, the plan has operated in accordance with the plan document; however, due to certain internal personnel changes in the human resources department, as well as a recent change in the external payroll service provider, bonus amounts have been includedin eligible compensation when calculating employee deferrals for over six months.

ELIGIBLE COMPENSATIONMistake: Plan operations didn’t follow the plan definition of compensation correctly for all deferrals and allocations.

How to fix: Make a corrective contribution or distribution.

Example monetary sanction under IRS audit:

4% of correction amount

ELIGIBLE COMPENSATIONHow to avoid the mistake: Review your plan document

• What does it say?

• What type of compensation is used as a starting point? Are any amounts excluded?

Verify current plan operations in place

• Are the plan’s election forms consistent with the plan terms?

Perform annual reviews of compensation definitions

ELIGIBLE COMPENSATION

• Determining contribution amounts

• Limiting annual contributions

• Performing non-discrimination testing

• Determining highly compensated employees (HCEs)

• Determining key employees for top- heavy rules

Uses for eligible compensation in 401(k) plans:

ELIGIBLE COMPENSATIONIRS limitations (verify each year):

• Annual compensation limit: $265,000

• Identifying HCEs: $120,000

• Key employee in a top-heavy plan: $170,000

ELIGIBLE COMPENSATIONPre-approved plan documents typically use one of three compensation definitions as a starting point:

Form W-2 wages

Federal income tax withholding wages

415 safe harbor compensation

ELIGIBLE COMPENSATIONCompensation

Type Form W-2 Comp Income Tax W/H Comp

415 Safe Harbor Compensation

Pre-Tax Elective Deferrals Excluded Excluded Excluded

Roth Contributions Included Included Included

Imputed Group Term Life Included Excluded Included

Taxable Moving Expenses Included Included Excluded

Nonqualified Plan Distributions Included Included Excluded

Military Differential Included Included Included

ELIGIBLE COMPENSATIONPlan document will define compensation and any adjustments/exclusions such as:

• Bonuses

• Commissions

• Severance payments

ELIGIBLE COMPENSATIONPlan document examples (1):

ELIGIBLE COMPENSATIONPlan document examples (2):

ELIGIBLE COMPENSATIONPlan document examples (2 continued):

WHAT WE DISCUSSEDSome of the common deficiencies or errors we will discuss include: Ensuring your plan has been amended for changes in

legislation Timely remittance of employee deferrals and loan

repayments Making mandatory distributions in

accordance with your plan document Using the appropriate eligible

compensation to calculate deferrals

Common errors:• Operational failures

Late / missed deferrals Miscalculated deferrals / match

• Failure to file 5500

Methods for correcting plans:1. Self Correction Program (SCP)2. Voluntary Correction Program (VCP)3. Delinquent Filer Voluntary Compliance Program

(DFVCP)

CORRECTED PLANS

Self Correction Program (SCP)

• Company finds problem and fixes it. No approval needed

• Must be operational failure discovered and corrected within two years of end-of-plan year when occurred

• Must fully correct and replace lost earnings

• Included as reportable transaction

CORRECTED PLANS

Voluntary Correction Program (VCP)

• Company finds problem, reports problem and requests forgiveness

• Can be for non-operational errors and errors older than two years

• Compliance fee (has to be paid by sponsor, not from plan funds)

• Issue is safe from future audit penalties (IRS) if approved for VCP

CORRECTED PLANS

IRS Employee Plans Compliance Resolution System (EPCRS)https://www.irs.gov/Retirement-Plans/EPCRS-Overview

401(k) Plan Fix-It Guidehttps://www.irs.gov/pub/irs-tege/401k_mistakes.pdf

Historical Examples of IRS Approved Corrections http://www.msba.org/uploadedFiles/MSBA/Member_Groups/Sections/Taxation/Study_Groups/EPCRS19932008.PDF

RESOURCES

Erin Falk, CPAefalk@skodaminotti.com440-449-6800

Marilea Campomizzi, CPAmcampomizzi@skodaminotti.com440-449-6800