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Take Charge of Your Company-Sponsored 401(k) Plan and Keep Things Running Smoothly

By: Mike Easton, CPA

Hardly a week goes by that we don’t see an advice column or two about how to save for retirement, how to make the best choices when you invest in a company-sponsored 401(k) or other deferred compensation plan.

While these considerations are important, business owners also have a serious obligation to understand what goes on behind the scenes in the retirement plans they sponsor for their employees.

So much of it seems routine: your business chooses a plan offered by a mutual fund, insurance or investment advisory company; your payroll department makes the appropriate payroll deductions; the third party administrator allocates the funds into each participant’s account; investments grow (more often than not), and everyone is happy.

Warning: don’t put your plan on autopilot and assume that everything will run smoothly.

As soon as your employees are paid, the amounts listed on their pay stub belong to them – so you’re handling other peoples’ money as it’s sent to the plan’s custodian of the investment assets and transferred into individual accounts. You can face harsh penalties if you do not meet your fiduciary responsibilities.

What’s more, two federal agencies – the Internal Revenue Service and the Department of Labor – monitor companies’ compliance with the fine print in their retirement plans. You want to make sure your company’s plan is managed so that it doesn’t attract any special attention from these agencies.

Here are some suggestions for keeping your retirement plan in order.

First, start with your plan document, the agreement you signed with the plan trustee that spells out how the plan will operate. This is gospel and you must follow it precisely.

A lot of the language will be investment and legal boilerplate, but some sections will be specific to your plan. Key sections include when employees become eligible for participation, what happens if their employment status changes (military or medical leave, switch from full-time to part-time, termination), whether bonuses and overtime are included when calculating contributions and/or employer matches, and procedures for handling loans and other distributions.

Next, appoint someone within your business to be responsible for day-to-day oversight of the plan. Someone must take ownership and have this responsibility. You cannot let it slide. This person’s responsibilities would include duties such as keeping up with changes in plan rules, making sure that all relevant company documents contain accurate and up-to-date information about the plan, getting paperwork to employees in plenty of time for them to enroll when they become eligible and notifying them when a change in status would affect their participation.

This person should also be responsible for reconciling all plan statements when they come in, whether it be monthly, quarterly or annually – just as you reconcile your checking accounts every month.

Following the basic business principle of segregation of duties, the person who reconciles the accounts should not be the one in charge of sending funds to your plan’s custodian of the investment assets each pay cycle.

Your company should receive two sets of statements – an overall statement that tells how much money has been deposited into the plan, where it is invested and how the stocks and funds in the plan are performing, and individual statements showing deposits, investment results and other activity for each plan participant.

There’s a disturbing reason for the mention of segregation of duties – while many businesses might not want to acknowledge the possibility, internal fraud can occur in the process of transmitting funds into and out of retirement plans and a good internal control environment and a regular, careful review of the statements is the best way to minimize the risk of fraud and detect it early. Personnel in payroll and human resources departments have been known to create accounts in the name of non-existent employees and later tap into those phony accounts for withdrawals and loans. Another common scam involves low-balance accounts of employees who no longer work for the company. There have been cases of unscrupulous payroll or HR workers withdrawing the funds from these often-ignored accounts, figuring nobody would be likely to notice.

In addition to reconciling the statements, your company should also undertake a periodic review of how your plan is operating. Do you have controls in place to verify that all eligible employees have been offered access to the plan? Do you have controls to account for unusual circumstances like medical leave, military service or temporary hires? Do you have controls to ensure that contributions, distributions and loans are calculated properly?

Your company’s top management – perhaps the CFO and/or a subcommittee of the board of directors – should also be paying attention to the overall performance of the funds included in the retirement plan to reduce the plan sponsor’s risk of breaking their fiduciary responsibility. If performance is not in line with generally accepted financial benchmarks, you should be talking to the plan’s investment advisor about adjusting the funds offered. If employees become dissatisfied with investment outcomes, they could lose confidence in the plan, and that could lead to poor morale.

While this should be obvious, I cannot emphasize enough the importance of processing employee contributions promptly and efficiently. For plans with fewer than 100 participants, the deadline is seven business days after the payroll date for which the salary deferral occurred. However, merely meeting that deadline is not always sufficient for the regulators to consider your plan in compliance. For example, if you regularly transmit contributions three business days after the payroll date, you could be cited and face penalties if you start making contributions five days after payroll. The general rule of thumb for timely remittance of employee contributions, regardless of the size of your plan, is as soon as is “administratively” possible. If payroll taxes are remitted within two or three business days, so should your 401(k) contributions.

Given the complexities of administering these retirement plans, it’s not unusual for the occasional “honest mistake” to occur. Recognizing this reality, the IRS has set up its Employee Plans Compliance Resolution System (EPCRS) as a mechanism to let plan sponsors correct common errors in a timely fashion while avoiding more severe penalties. Suffice to say that it’s better to fix a problem on your own than to have the IRS or DOL conduct an audit and tell you how to fix it.

On its website, the IRS offers a “401(k) Plan Fix-It Guide” which lists the most common mistakes, how to find them, how to fix them and how to avoid making the same mistake again.

In general, the guiding principle concerning contributions and distributions is that plan participants not suffer any loss as a result of mistakes made by the plan sponsor. For example, if your business forwards contributions to the plan’s custodian of the investment assets and excludes from the calculation certain compensation which meets the definition of compensation, such as bonuses or fringe benefits, then your business would be responsible for making the participants whole by making additional contributions to the plan, including lost earnings, regardless of respective investment performance. In many cases, the plan sponsor may also be subject to an excise tax.

There’s more work than you might think in making sure your retirement plan is managed properly, but the additional work is manageable if you do it properly. Read your plan document, put someone responsible in charge, reconcile all your statements promptly and fix any mistakes as soon as you notice them.

If you follow those basic guidelines and your plan participants make wise investment decisions, you and everyone within your business will be on their way to a comfortable retirement.