by Robert Behr, CPA
Plan sponsors (employers) typically adopt a “proto-type” plan that has been pre-approved under the Internal Revenue Code (IRC). The proto-type plan enables the sponsor to configure the plan based on the preferences of the organization.
Some of the key features determined by plan sponsors are: (1) When are employees eligible to participate in the plan, (2) Types and amounts of allowable employee contributions, (3) How much will the plan sponsor contribute and how will it be allocated among participants, (4) Vesting period for participants, (5) How and when benefits are paid. Setting up the plan document is a relatively simple task. However, monitoring and ensuring that terms of the plan are being followed can be challenging.
Some of the more common errors that plan sponsors make administering their plan consist of:
* The plan definition of eligible compensation is not correctly followed. Eligible compensation is not the same for every plan. It is determined by the plan sponsor and may include or exclude items such as overtime, sick, vacation, severance, bonus and other types of compensation. This can result in participant elective deferrals and employer matching contributions being miscalculated.
* Employer contributions are not made to all eligible employees. It is imperative that all participants are treated equally and fairly in accordance with the plan document as ERISA has required nondiscrimination testing.
* Participant elective deferrals are not handled correctly. While it is up to the participant to select the percentage of their salary to contribute to the plan, it is the plan sponsor’s responsibility to ensure the amount is calculated correctly, withheld and deposited into the plan timely.
* Eligible participants are not given the opportunity to participate in the plan. You need to make sure that you have a process in place to enroll your employees once they meet the eligibility requirements.
* Employee loans are not paid in accordance with plan rules. Generally, an employee loan is secured by their vested interest in the plan. The amount that the plan may loan an employee is limited by certain rules under the IRC.
* Vesting periods are misinterpreted. It is important to understand how this is calculated if your plan offers an employer contribution. Vesting is a percentage typically based on years of service. If the percentage calculated is incorrect, it may impact the amount an employee can borrow from the plan or the amount of money paid in distributions when an employee terminates from the plan.
* Distributions are not calculated or paid correctly. The incorrect calculation of an employee’s distribution can certainly be impacted by the misinterpretation of the vesting period. Also, when an employee requests a distribution, a determination must be made on whether federal income taxes are required to be withheld from the distribution, and if required, how much should be withheld. Distributions of pre-tax employee deferrals and employer contributions from a 401(k) or 403(b) plan are subject to federal income taxes unless the distributions are rolled over into another qualified retirement plan or traditional IRA within 60 days of the date of the distribution.
* Forfeitures are not used appropriately. Forfeitures generally exist in plans with vesting periods. If a participant terminates employment before being fully vested, then the non-vested portion of the terminated participant’s account balance remains in the Plan and is called a forfeiture. As determined by the plan document, forfeitures are typically used to pay administrative expenses and/or reduce employer contributions to the plan.
It is important to remember that as the employer you have a fiduciary responsibility to ensure the plan is administered in accordance with the plan document. By performing an annual review of your plan and subsequent amendments, it will help mitigate the risk of non-compliance issues with the Department of Labor and Internal Revenue Service.