401(k) Plan Reviews Help Avoid Compliance Mistakes
Additional Information
While 401(k) plans offer employers and their employees tax-favored opportunities to save for retirement, as tax-qualified retirement plans under the Internal Revenue Code (“IRC”) and covered by the Employee Retirement Income Security Act (“ERISA”), they are also subject to numerous legal compliance requirements under such laws. These requirements apply generally upon the plan’s establishment and throughout the plan’s term.
Accordingly, employers must review the 401(k) plan requirements to ensure ongoing plan compliance with applicable law. Such a review should be undertaken no less frequently than annually. Failure to comply with these 401(k) plan requirements can result in the disqualification of the plan under the IRC and the related loss of the favorable tax benefits associated with 401(k) plans, as well as the imposition of monetary penalties and liability.
Below is a checklist of compliance requirements for operating a 401(k) plan that should be periodically reviewed.
Timely Plan Amendments. 401(k) plans, as is the case generally with all tax-qualified retirement plans, must be timely amended for applicable changes in the law (via statutory, regulatory, or other government-mandated plan changes), as well as for discretionary or optional plan changes (e.g., changes to the level of contributions). In addition, changes to the plan document will often also require changes to the 401(k) plan’s summary plan description (or, as applicable, reflected in a summary of material modification).
Operate the Plan under its Terms. Failure to operate the plan following its terms can result in adverse tax consequences and a breach of fiduciary duty.
Ensure that a proper definition of “Compensation” is used under the plan. A participant’s “compensation” is relevant for purposes of calculating contribution allocations, as well as in complying with specific IRC-required nondiscrimination testing requirements.
Confirm Applicable Employer Matching and Nonelective Contributions are Timely and Properly Allocated to Eligible Participants.
Comply With Applicable Contribution Nondiscrimination Tests.
401(k) plans must pass unique nondiscrimination requirements that apply to matching contributions and employee after-tax contributions on the one hand, and voluntary salary deferrals (pre-tax and Roth contributions) on the other. The contribution levels allotted to higher-paid members are typically restricted by these tests. The employer may be subject to further tax penalties if noncompliance with these nondiscrimination standards is not promptly corrected.
Ensure all Eligible Employees Have the Opportunity to Participate in the Plan.
If qualified employees are improperly excluded from the 401(k) plan, the company may be required to make “corrective additional contributions” to the plan.
Ensure Elective Salary Deferral Contributions do not Exceed the Annual Limit.
All 401(k) plans have an annual calendar year cap on elective salary deferral contributions, which is set by the IRS. All 401(k) plans have a $19,000 cap on elective salary deferrals for 2019. The maximum amount for “catch-up” voluntary salary deferrals for members 50 years of age or older in 2019 is an extra $6,000 (if the plan otherwise allows such catch-up contributions). The IRS may modify these cash restrictions every year in response to shifts in the “cost of living.”
Timely Contribution of Elective Salary Deferrals to the 401(k) Plan.
Generally, under ERISA, elective salary deferrals must be deposited into the plan no later than the earliest date such amounts can reasonably be segregated from the employer’s general assets. A special safe harbor deposit timing rule applies to “small plans” (i.e., less than 100 participants as of the beginning of the plan year). Failure to timely deposit elective salary deferrals can result in a “prohibited transaction” under the IRC and ERISA.
Ensure Plan Loans are Property Administered.
Although members may take out loans from their 401(k) account (if the plan allows them to do so), the amount of the loan will be taxable to the participant if it does not meet legal criteria or is not promptly repaid.
Ensure “Hardship” Distributions are Properly Administered.
If a person has a “immediate and heavy” financial need that is typically unmet by other accessible financial sources, 401(k) plans may permit them to receive a distribution while they are still employed. The rules and processes of the plan must be legally compliant in order for hardship distributions to be issued. The IRS has updated and relaxed the regulations for hardship payouts.
Is a “Top-Heavy” Plan Minimum Contribution Required?
Assume that a 401(k) plan is “top-heavy,” meaning that the account balances of “key employees” surpass 60% of the account balances of all enrollees. In that scenario, all “non-key employees” will be required to make a minimum contribution to the plan. In general, small employer plans are more likely to have top-heavy plan status.
Timely Form 5500 Annual Reporting Requirement.
Annual information returns, or Form 5500 Reports, are required to be submitted by 401(k) plans to the US Department of Labor. The size of the plan generally determines the type of Form 5500 report and the extent of the material needed in the report (for example, plans with 100 or more participants usually need to include an independent plan auditor report with the Form 5500 file). Significant late filing penalties may be incurred if Form 5500 reports are not filed on time, which is typically by the end of the seventh month after the end of the plan year, unless the deadline is extended.
As you can see, 401(k) plans must adhere to a number of regulatory regulations; noncompliance can result in significant expenses and penalties. Employers who support 401(k) programs are therefore strongly
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