Employee benefits and retirement plans must comply with various laws and regulations to maintain their tax-qualified status. Some errors that can cause a plan to lose its tax-qualified status may occur in the underlying plan document.
More commonly, the error will result from a failure to follow the terms of the plan, and even a small error can cause the plan to lose its qualified status. If a plan loses its tax-qualified status, employees may have to include plan contributions and any increases in the plan’s value in their income and pay taxes on their contributions.
Many employers regularly perform voluntary plan audits that can uncover errors. However, you can spot errors without a third-party audit. Below are some of the most common employee benefits and retirement plan mistakes.
8 Mistakes to Avoid
- Failing to maintain a current signed copy of the plan.Some employers hire a third-party administrator (TPA) to manage their plan. Often, the TPA prepares the plan documents, but the employer needs to sign those documents to adopt or amend the plan. You should always have a fully signed copy of the plan documents in your files (including the adoption agreement, any amendments, and the underlying plan document).
- Understanding who’s responsible for keeping the plan qualified.An employer will enter into agreements with its TPA to set forth who is handling which part of the plan administration. While the TPA might handle the qualification testing, the employer often is ultimately responsible for maintaining the plan’s qualified status. You should understand who is on the hook for any failure to maintain the plan’s qualified status, and for the cost of fixing a failure, before a failure occurs.
- Missing employee deferrals.Employees can change their elective deferrals periodically. You must ensure you have proper procedures in place for timely updating your payroll system to change deferrals. If you fail to defer a portion of an employee’s compensation, you can correct the mistake. Many employers incorrectly contribute, on behalf of the employee, the full amount he would have deferred. However, since the employee received in his paycheck the funds that should have been deferred, the correction involves contributing only part of the missed deferral, plus missed earnings.
- Failing to follow the plan’s definition of compensation.Plans can define “compensation” to include certain types of wages, including overtime, shift differentials, on-call pay, and bonuses. Sometimes, one or more types of compensation are coded incorrectly, and the elective deferrals or employer match is calculated using an incorrect number for compensation.
- Improperly matching employee contributions.This can occur because you used the wrong definition of compensation or just made a mathematical error. An error in calculating an employee’s elective deferral will also typically result in improper matching.
- Improperly paying unvested amounts to departing employees.If an employee leaving your company requests a payout of her account, you should double-check the plan’s vesting schedule before processing the payout. This can be accomplished by providing proper directions to the TPA (or knowing who is responsible for determining how much is vested) or providing guidance to internal HR staff.
- Failing to automatically increase deferrals as required under certain safe-harbor plans.Certain plans provide for an automatic increase in annual contributions unless an employee opts out of the automatic contribution. When a plan includes automatic contributions (or automatic increases), there should be a mechanism or process for determining when employees’ contributions will automatically increase. Depending on the timing of the plan year and the employee’s start date, some confusion may occur. For larger employers, it can be a challenge to track contribution changes unless the payroll system is able to automatically perform the calculation.
- Not correcting plan failures.Occasionally, an employer fails to comply with the specific IRS rules on how to fix a failure. For the plan to maintain qualified status, a failure must be fully corrected, and you may have to notify the IRS to receive its blessing on the manner of correction.
Generally, the earlier a mistake is corrected, the easier and less expensive the fix will be. As soon as an error is discovered, contact your TPA and your employee benefits counsel to determine the appropriate correction as well as your next steps.
Jana Weiler and Courtney Strutt Todd—contributors to Iowa Employment Law Letter—can be reached at firstname.lastname@example.org email@example.com, respectively.
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