'Wrong' Headed?

In this as, perhaps, many professional endeavors, it seems that the more you know, the more you know you don’t know. Moreover, the standards imposed on plan fiduciaries by the Employee Retirement Income Security Act (ERISA) are not only demanding, they may be the highest found in law—and with personal liability imposed, to boot.

About a year ago, I compiled a list of “10 things you're (probably) doing wrong as a plan fiduciary.” By all accounts, it was well-read, much forwarded, and useful in terms of helping plan sponsors and retirement plan advisers highlight areas of possible improvement with your plan sponsor clients.

The list that follows – think of it as “10 things you’re probably STILL doing wrong as a plan fiduciary” - is a compilation based on my experience, the experiences of a group of experts who conducted a panel by the same title at the PLANSPONSOR National Conference in June, and a list of “Common Plan Mistakes” from none other than the Internal Revenue Service itself. Once again, I hope you find this list informative—and that you draw insight and comfort from its contents.

1. Not following the terms of your plan document regarding the administration of loan provisions (maximum amounts, repayment schedules, etc.) or hardship withdrawals.

Plan documents routinely provide that hardship distributions can only be obtained for certain very specific reasons, and that participants first avail themselves of all other sources of financing before applying for hardship distributions (these conditions often are incorporated directly from the requirements of the law). Similarly, loans are permissible from these programs only when they comply with certain standards regarding the amount, purpose, and repayment terms.

Failure to ensure that these legal requirements are met can, of course, most obviously result in a distribution not authorized under the terms of the plan document—and, since these types of distributions are frequently quickly spent by participants (and thus not readily recoverable), it can be complicated and time-consuming to set the situation right.

2. Failure to follow plan document eligibility and vesting provisions

An employee’s rights to retirement benefits are determined by the correct application of service and/or age requirements of the plan regarding eligibility for participation, and also may be influenced by the proper application of the plan’s vesting schedule.

To properly comply with those requirements, you need to maintain accurate service records for all employees. If these records are incorrect, the benefits provided may be incorrect—either in excess of what is permissible or less than what was due to the participant. Note that the failure to properly follow the plan’s provisions can cause the plan to lose its qualified status.

The plan document serves as the foundation for plan operations; it is, quite simply, the operating manual for your program. Sometimes, particularly if you are relying on a document that has been prepared by a third-party service provider, certain “gaps” can emerge between what the document allows and how the plan is actually administered. As a result, it is a good idea to conduct a document/process “audit” every couple of years—don’t assume that “the way we’ve always done things” is supported by the legal document governing your plan.

3. Improperly managing forfeiture accounts

Many defined contribution plans require participants to complete a period of service before becoming fully vested in matching or non-elective employer contributions, and when a participant leaves the play before they are fully vested, their unvested account balance may be forfeited. Some plan administrators place these forfeited amounts into a plan suspense account, allowing them to accumulate over several years. However, the Internal Revenue Code does not allow this practice. Forfeitures must be used or allocated in the plan year incurred.

Revenue Ruling 80-155 states that a defined contribution plan will not be qualified unless all funds are allocated to participants’ accounts in accordance with a definite formula defined in the plan, and the IRS notes that this would preclude a plan from carrying over plan forfeitures to subsequent plan years, as doing so would defy the rule requiring all monies in a defined contribution plan to be allocated annually to plan participants. The plan document’s terms should have provisions detailing how and when a plan will exhaust plan forfeitures.

4. Not starting required minimum distributions (RMD) on time

A minimum payment must be made to the participant by the required beginning date (RBD) and for each following year. Normally, the RBD for a participant who is not a 5% owner is April 1 following the end of the calendar year in which the latter of two events occurs: either the participant reaches age 70½ or the participant retires (for 5% owners, the RBD is April 1 following the end of the calendar year in which they attain age 70½ regardless of their retirement date).

Plan sponsors often discover that required minimum payments either have not been paid timely or at all, especially when a non-5% owner continues working after reaching age 70½. Failure to follow the minimum payment rules as written in the plan document can lead to the loss of the plan’s tax-qualified status. If participants or beneficiaries do not receive their minimum distribution on time, they (not the plan) are subject to a 50% additional tax on the underpayment.

5. Not depositing contributions on a timely basis

The legal requirements for depositing contributions to the plan are perhaps the most widely misunderstood elements of plan administration. A delay in contribution deposits is also one of the most common flags that an employer is in financial trouble—and that the Labor Department is likely to investigate.

Note that the law requires that participant contributions be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets, but no later than the 15th business day of the month following the payday. If employers can reasonably make the deposits sooner, they need to do so. Many have read the worst-case situation (the 15th business day of the month following) to be the legal requirement. It is not.

Editor’s Note: the other five things will appear in next week’s column.