The harsh reality is you may pay more in fees than what is in your retirement! This is the unfortunate reality many are facing, as the Department of Labor estimates 77 percent of 401k plans are out of compliance. To be deemed “qualified,” a 401k plan must satisfy the requirements listed under the Internal Revenue Code Section 401(a). If a plan fails to meet these requirements, then the plan is deemed “disqualified” and favorable tax benefits may be lost.
To avoid these losses and extra fees, 401k retirement plans should be reviewed every year. Use this informal checklist as a means to keep you compliant.
- Does your plan reflect recent changes?
A 401k plan must be supported by a formal written document that complies with the Internal Revenue Code. Anytime there is a change, the written document must be amended to reflect the most recent change. Generally, the IRS establishes a deadline by which all changes must be adopted. This requirement applies to all 401k plans for as long as assets remain in the plan. To stay up-to-date on any changes you may review the Notice 2013-84. To avoid any mistakes moving forward consider using a calendar noting when changes must be complete. Review your document annually and always keep constant contact with the company that sold you the plan.
- Do the plan’s operations adequately follow the terms of the plan?
Failure to comply with the plan’s terms is the most common mistake revealed during an audit. The most important thing to remember here is that although the employer is responsible for keeping the plan in compliance there may actually be many others servicing your plan. If that is the case, everyone should be aware of any changes made to your plan, whether that is modifications to how you operate your plan or changes made to plan trustees. Developing a communication plan can help keep all fiduciary partners reliable.
- Do you use the proper definition of compensation for all deferrals and allocations?
You may use different definitions of compensation for different purposes so it is important that you use the proper definition for deferrals, allocations and testing. According to the IRS, a plan’s compensation definition must satisfy rules for determining the amount of contributions. One such rule is that the amount of compensation under the plan can’t exceed $260,000 in 2014 (subject to cost-of-living adjustments in later years.) The best practice to ensure definitions are followed is to perform an annual review of compensation definitions and also make sure whomever is in charge or determining compensation is properly trained, and that align with your own providers definitions.
- Were terms followed with regards to employer matching contributions?
Make sure that what you say you will do, you do. Review the plan document to determine the employee eligibility requirements and matching contribution formula and make sure that is congruent with operations. If need be, contact your plan administrators to ensure they have adequate payroll records to make the proper calculations.
- Could your plan pass the Actual Deferral Percentage/Actual Contribution Percentage nondiscrimination tests?
Every 401k plan, with the exception of certain auto enrollment and 401k safe harbor plans, must satisfy the annual ADP/AFC nondiscrimination tests. These tests ensure that contributions for less highly compensated employees are proportional to contributions made for owners and managers (highly compensated employees). For more information on what these tests actually determine, see page 25 of this 401k Plan Guide provided by the IRS. Make sure you are communicating with plan administrators about proper employee classifications to stay compliant with plan terms. In most cases, to avoid testing, you may consider a safe harbor or auto enrollment plan.
- Did you mistakenly exclude an eligible employee from making a deferral?
In the case of elective deferrals, don’t assume you know who is eligible and not. Rather, treat each employee who receives a W-2 as eligible unless determined otherwise by plan terms. If you do make this mistake; however, make a qualified non-elective contribution in order to compensate employees for the missed deferral opportunity. To avoid this, monitor census information and apply participation requirements.
- Are elective deferrals limited to the amount specified under IRC 402(g) for the calendar year?
IRC 402(g) indicates limits for elective deferrals plan participants can exclude from taxable income in a calendar year. This limit under section 402(g) is $17,500 for 2014. Make sure to inspect deferral amounts of plan participants to ensure deferral limits aren’t exceeded. Failure to distribute deferrals in excess of the limit may result in additional taxes and penalties for both the employer and participant.
- Are employee elective deferrals deposited in a timely manner?
Make sure you know the earliest date you can segregate deferrals from general assets and compare that date with the actual deposit date to ensure you don’t miss a deadline. If you miss the deadline for contributing participant deferrals to the plan trust you may have to pay an excise tax – determined by the amount involved in the transaction. The initial tax is 15 percent on the amount involved, but if the transaction goes unpaid an additional tax of 100 percent of the amount may be due. As soon as you can deposit deferrals you should, and in no event should the deposit be later than the 15th business day of the following month, or 7 business days after payroll for plans with less than 100 participants.
- Do participant loans conform to the requirements of the plan and IRC Section 72(p)?
Many 401k plans permit loans to participants. Before allowing participants to borrow money from the plan, be sure your plan document allows for this type of transaction. Be sure to review the plan document and all outstanding loans to ensure employees are repaying their loans in a timely manner. Make sure you have procedures in place to prevent loans that are prohibited transactions and ensure plan provisions on loans are being followed. Violations may be treated as taxable distribution to the participant. Also, ensure your plan document explains who is responsible for collecting delinquent loan payments.
- Were plan terms followed with regards to hardship distributions?
Because life happens, a 401k plan may allow employees to receive hardship distribution due to immediate financial need. According to law, a hardship distribution may be made because of:
- Medical care expenses incurred by the employee, employee’s spouse or dependents;
- costs directly related to the purchase of a principal residence (excluding mortgage payments);
- payment of tuition, related educational fees and room and board expenses for the next 12 months of post-secondary education for the employee, employee’s spouse, children or dependents ;
- payments necessary to prevent eviction from an employee’s residence or foreclosure on that residence;
- funeral expenses and
- certain expenses relating to the repair of damage to an employee’s residence.
Be sure you are constantly amending the plan to allow for hardship distributions and make sure you understand the provisions aligned in the plan document and follow them through in operation.
If you can answer no to any of the questions above your 401k plan may not be in compliance. Granted this list is only a guideline to a more compliant plan, just because you answered yes to all these questions does not automatically make your plan 100 percent compliant. For complete ease of mind, be sure to contact your advisor.