The 411 on Employee Benefit Plans

As we’re now into the second half of 2010, I thought I’d share some advice I read recently in Sunday newspaper.  Charles Schwab is encouraging individuals to perform a mid-year review of their 401(k) investments through the following simple processes:

• Rebalance – Rebalancing means adjusting the allocations to the funds in your account back to their original targets.  The difference in performance between funds in your 401(k) account over time can cause your asset allocation to look very different from your original plan.
• Max out your company match – Are you contributing enough to take full advantage of the matching benefit your employer may be offering?  Consider increasing your contribution to do so if you haven’t already.
• Put your raise to work – As the economy has picked up slightly, some employees have received raises over the past year.  If you were one of those employees, did you increase your 401(k) deferral percentage, too?  Salary increases are a great opportunity to boost 401(k) savings, because it gives you the opportunity to take home some of the additional income today while also putting additional savings away for your retirement years.
• Consider your mix of investments – Have new investment options become available?  Are you comfortable with the current level of risk in your investment mix?  This should be evaluated on an ongoing basis.
• Take a look at your current beneficiaries – Have you had any recent changes in your family situation over the past six months?  If you’ve recently married, divorced or had a child, you’ll want to make sure you’ve updated this.

Spending a few moments evaluating the above recommendations is good way to ensure your 401(k) plan is set up to meet your long-term retirement savings plan and goals.

Jessica Puckett, CPA, CFE

In order to ensure that employee benefit plans do not violate certain standards that the DOL and IRS believe are important, plans are subjected to annual compliance tests. These tests are designed to ensure that the amount employees are deferring is within certain maximum limits and that plans are not operating in a manner that discriminates against certain classes of employees. The most common compliance testing performed by defined benefit plans on an annual basis are the ADP and ACP Tests, the Top-Heavy Test, the 415 limits testing and the multiple use test.

The ADP and ACP Tests were discussed in a previous blog and we will cover the 415 limits testing and multiple use test in future articles. Following we will address the Top-Heavy Test.

All qualified plans must satisfy the top heavy requirements of IRC 416. To determine if a plan is top-heavy, the key employees must be identified. A plan is considered to be top-heavy when the combined plan assets of the key employees total 60% or more of the plan’s total assets. An employee is considered to be a key employee if, at any time during the plan year, he or she was:

• An officer of the company with annual compensation of $130,000 or more.
• One who owns greater than 5% of the business or a family member of a %5 owner.
• One who owns greater than 1% of the business and earns more than $150,000 a year.

In order for an officer to be considered a key employee, the officer must be an officer-in-fact and not just an officer-in-title. The number of officers considered to be key employees is limited to the greater of three or 10% of the employees and, regardless of the number of employees, no more than 50 officers are considered to be key employees. A 5% owner is considered to be an employee who owns more than a 5% interest in a corporate employer, or more than 5% of the employer’s outstanding stock or combined voting power.

When a plan is determined to be top-heavy, a minimum mandatory contribution is required to be made by the employer. The minimum mandatory contribution is made by the employer on behalf of all non-key employees still employed as of the last day of the plan year. Generally, the required minimum mandatory contribution is 3% of non-key employees’ salaries; however, if key employees are contributing less than 3% but more than 0%, a contribution equal to the highest contribution percentage of any key employee must be made to each eligible non key employee.

Joe Goodmiller

Plan Sponsors often fall short in one simple area of plan administration: record keeping. It is important that Plan Sponsors keep proper documentation for each area of the Plan.  One important area for this documentation is administering hardship distributions to participants. As described in our blog, “Hardship Distribution Requirements”, if your plan allows for hardship distributions, you as the Plan Sponsor should have proper procedures in place to determine the employee has immediate and necessary need for the funds.

If you are not sure proper documentation has been retained for hardship distributions for your Plan, review all distributions made during the year and determine which were distributed as hardships. For each of the hardship distributions, review the documentation to determine if each meets the hardship distribution requirements set forth by the Internal Revenue Service. Also review for any signs that the hardship distribution is being abused by employees. If there are quite a few hardship distributions, this may be a sign that the hardship distributions are not being properly administered.

If you do find a mistake with the administering of hardship distributions within your plan, there are some corrective measures that can be taken. For example, if you have determined that proper documentation was not retained for hardship withdrawals, you may correct this under the Voluntary Correction Program (VCP). As the Plan Sponsor, you must request that the participants who did not provide proper documentation and did not meet the hardship requirements repay the amounts plus earnings to the plan. This could be a tedious act as most participants would have previously spent their distribution. Correction may include paybacks, employer corrective contributions and even some form of plan amendment. Each situation will be different and therefore, you should file an application with the VCP and work with an agent there to determine the appropriate correction necessary.   Additional information about deficiencies found and remedies recommended by the IRS can be found at this IRS website.

In addition to correcting the specific participants, the Plan Sponsor must improve the plan’s administrative procedures in order to keep it out of further trouble with regards to hardship distributions. Whenever a hardship distribution requests is submitted, it is important for the Plan Sponsor to require additional documents to be received and placed on file with the request to back up the hardship. This will show that adequate steps have been followed by the Plan Sponsor to determine that the employee does in fact have a need that is immediate and necessary for the funds.

For further information on what is required for a hardship distribution to be taken, visit the Internal Revenue Service’s website.

Shelby Williams

Lately I’ve run across several articles in the news that give a gloomy outlook for pension plans, including the State of Arizona’s Public-Pensions.  According to a recent report in the Arizona Republic, tightening budgets and poor investment performance have some wondering if the funds can continue to meet their obligations to retirees.  Citing a new report by the Arizona Chamber of Commerce and Industry, Arizona plans face a deficit of more than $10 billion – a shocking decline from the nearly $5 billion surplus reported 10 years ago.

And Arizona isn’t the only one with this concern.  The CPA Journal touched on this issue as well, and provided some startling facts:

• The City of Cincinnati has only been making partial contributions to its Plan over the last several years.  Its unfunded liability was $913 million in 2008.
• The PBGC, which protects retirement benefits for people when underfunded defined benefit plans collapse, reported a $33 billion deficit for the first half of 2009.  This is triple the deficit reported in 2008.
• Further, in the month of June 2009, the PBGC assumed responsibility for 5 underfunded plans.  Their combined deficit was $233 million.

In order to respond to their deficit, the Arizona State Retirement System is requiring an extra ½% contribution over the next two years, and they will add more increase in future years to increase their funding levels.  Also, plans are continuing to move from defined-benefit plans to defined-contribution plans.  Regardless, it appears defined benefit plans are due for some reform to ensure there will be adequate funds available for the current and future retirees that are or will be depending on them.

Jessica Puckett, CPA, CFE

Everybody has that thought.  You hear news about another poor day in the stock market, which makes you reflect on how that is impacting your 401(k) retirement savings.  You also receive your quarterly retirement account statement and see how it has decreased in value over the past quarter, which frustrates you.  That is not the time for such a rash decision to start moving all the money around between funds in your 401(k) retirement account.  Your retirement account is built for long-term increases in value.  Regularly moving balances between the various funds in your retirement account will undermine the long-term retirement goals that you have established for yourself.  That doesn’t mean you should completely ignore your retirement account.  It is important to review the quarterly statements received from your plan’s custodian to monitor your investments and make it a point to at least annually review your retirement investments to ensure they are in line with your long-term retirement goals.

There are many reasons why it is important to do this at least annually.  There may have been changes in your life recently, whether it is buying a new home, having children, or reaching a milestone birthday that impacts your current retirement goals and investment mix.  Also, your plan sponsor occasionally may alter the funds available under the plan.  They may have replaced a fund you are currently invested in with another fund that is said to have the same investment strategy.  However, the new fund may not exactly match the composition of investments needed to align with your retirement goals.  It would be wise to make that determination as soon as possible in order to minimize the time your funds are in an investment mix that is not right for you.

There are many available options to assist you with analyzing your current investment mix in relation to your retirement goals.  Often, your plan sponsor utilizes an investment advisor for the plan who is available to sit with participants to discuss their goals and determine the proper 401(k) investment mix.  These investment advisors may visit your workplace at certain times of the year; however also make themselves available when participants have investment questions.  The plan’s custodian may also provide a representative to visit your workplace and discuss investment related questions as well as other questions you may have related to the plan.  The custodians also often provide tools on your plan’s website to help you evaluate your investment goals and select funds in the retirement plan portfolio that work for you.

Furthermore, you can take a proactive approach in evaluating the funds offered in your 401(k) retirement plan. If the plan sponsor plans to alter the makeup of your 401(k) plan, you should stay informed of the process and get involved if you can.  You should also evaluate if there are too many investment options offered.  This may be a sign that your employer, as trustee, isn’t doing enough to select the proper blend of investment options for the plan participants.  They may be just selecting all that are available and letting the participants sort it out.  If that is the case, you may want to talk to your employer about evaluating their investment mix as part of their fiduciary responsibilities.

As you can see, there are a number of ways to have an active say in your long-term retirement goals.  Reviewing your quarterly statements and making it a habit to evaluate your investments annually will go a long way in assisting the long-term performance of your investments.

Jonathan Poppel, CPA

Important Background
The reporting requirements for 401(k) benefit plans require that certain disclosures are included in the footnotes. This blog post will discuss one new disclosure “Managements Review of Subsequent Events”, which is effective for Plan Year Ends after June 15, 2009.

For Non-SEC filers – the Accounting Standards Codification (“ASC”) requires that an entity recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.

The ASC defines subsequent events as follows:
“Events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. There are two types of subsequent events:
a. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events).
b.  The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (that is, nonrecognized subsequent events).”

In addition to the recognition requirement the ASC requires that the entity disclose both a) the date through which subsequent events have been evaluated by management, and b) the date the financial statements were issued or the date the financial statements were available to be issued. 
 
Financial statements are considered available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained, for example, from management, the board of directors, and/or significant shareholders/owners. The process involved in creating and distributing the financial statements will vary depending on an entity’s management and corporate governance structure as well as statutory and regulatory requirements.

Financial statements are considered issued when they are widely distributed to shareholders/owners and other financial statement users for general use and reliance in a form and format that complies with GAAP.”

What does this mean for my 401(k) Plan?
If you are responsible for your Plan (i.e. Trustee, main Fiduciary) you may be wondering how this requirement affects your Plan.  The requirement forces you as Fiduciary to disclose in writing that you have reviewed all subsequent events that occurred after your Plan Year End date for possible recognition in the financial statements as of the Plan Year End date, or for disclosure in the footnotes. If a footnote disclosure is not included in your Plan’s December 31, 2009 (or later) financial statements, then your financial statements are not in accordance with U.S. GAAP. 

Victor Fuentes

You’ve read all the articles and DOL publications about how to choose a Third Party Administrator (TPA) (see Monitoring your TPA, Selecting a TPA, Duties of Plan Administration, and Fiduciary Responsibilities). You’ve done the research, and you feel like you’ve hired a competent company to administer your plan. And so you just go about your business, keeping an eye on the plan, but not really getting into it. One day you see a letter in your inbox with a return address from the IRS – you are officially being notified that you are 3 years delinquent in filing your 5500 and as such you are also going to be required to submit to an IRS/DOL audit. Think this couldn’t happen – think again. A friend of mine found herself in this very situation. And to make matters worse, upon further investigation she came to the shocking realization that the TPA had been fraudulently charging them for various things. The tipping point was realizing they had charged for an hour long conversation with the company attorney, and they had never seen the charge from the attorney for this alleged conversation.

When I asked her about it, she was just so upset that the TPA hadn’t filed the forms and were giving her all sorts of excuses about why they hadn’t taken care of things. And while I totally agreed and could almost sympathize, she was rather taken aback when I inquired if she realized that she was ultimately responsible for filing the appropriate forms and returns, and ensuring that the plan was compliant. She was mistakenly under the impression that the TPA was going to take care of it, and now, because of her own ignorance about her specific fiduciary responsibilities that extend beyond hiring the right company, she was about to spend thousands of dollars and countless hours trying to make everything right. If you are like my friend and think that you have a good TPA and you can trust them to take care of things, I’m not saying that you can’t trust them to do their job, but you as the plan sponsor are directly responsible for compliance and timely filing. So have those discussions with your TPA about what needs to happen and who will do what. And don’t hesitate to ask them when things will happen and how you will know that such things, like filing your 5500, have been taken care of. They may do most of the work, but they still work for you.

Katie Thomas, CPA

Audit fees for a 401k vary from firm to firm and are generally based on the size of the plan and the level of assistance the auditor receives from the plan administrator. Generally, the more work the auditor performs, the higher the audit fee.  As a plan administrator, you can manage the size of your plan to some extent and you have complete control of how much assistance you provide the auditor.

Size of Plan

Did you know that terminated employees who are still in your plan cost you extra fees? Much of the audit work is completed based on the participant counts, which include eligible current employees and terminated employees with account balances. Most plans have guidelines for automatic distributions to terminated employees with small balances. Work with your third party administrator or ERISA attorney to ensure you are making the most cost effective decision for your plan. 

Level of Assistance

As a plan administrator much of the audit fee is in your control. The more you do, the less your auditor has to do. The less work your auditor does, the less you pay!

Your auditor should send you a detailed list called a “Client Assistance Request List” or “PBC List” (PBC = Prepared By Client). This should represent the majority of information your auditor will need to complete the audit. As a result, this document is your guide to minimizing fees. Here’s how:

Gather all the information on the list and provide it to your auditor all at once. Most auditors have several clients they are working on simultaneously, the fewer times they have to put down and pick-up your file the less time will be spent on.

If you have questions about something on the PBC List, ask your auditor. Each item on the PBC list has a purpose and providing the wrong thing to the auditor adds time. Similarly, not providing anything causes additional work for the auditor too. Answer no or indicate why you haven’t provided a requested item.

Eliminate the excess. An auditor’s job is to investigate and inquire. If we are given extra paperwork or unrequested documentation, we expect that you have provided it to us for a reason. We will likely review it and ask you why it was provided. Further, most 401k auditors will request documents from the employees’ personnel files. Rather than pulling the entire employee files and handing them to the auditor, flag the specific documents requested or pull them and provide only what has been requested. And if you don’t understand what the auditor is looking for, ask.

Questions from the auditor are inevitable; regardless of how prepared you are as a plan administrator. To minimize fees, respond to the auditor as quickly as possible. They may inquire regarding unusual transactions or may be waiting to hear back regarding the approval of the draft financial statements; the less time the auditor waits the less downtime for your plan and the fewer the excess fees.

A management letter is the plan administrator’s guide to fewer future audit fees. Auditors use the management letter as a tool to advise management as to errors and inefficiencies noted during the audit. Often they include a recommendation for how to prevent the errors or improve the processes going forward. Implementing recommendations from management letters will make for better administration of the plan and as a result, fewer fees.

If you are concerned about your audit fee, talk to your auditor. In addition to recommending the tips I have listed above, they will be able to specifically tell you how your plan can reduce fees.

Jill Smith

If your plan allows for hardship distributions, as a Plan sponsor you are required to verify that proper evidence has been obtained which verifies the participant has immediate and necessary need for the distribution.

The Internal Revenue Service (“IRS”) has stated that certain expenses are considered immediate and necessary. These expenses include the following:
• Medical expenses,
• Purchases of a principal residence,
• Certain tuition and other educational expenses,
• Prevention of foreclosure of principal residence,
• Burial and funeral expenses, and
• Certain repairs of damaged principal residences.

As the Plan Sponsor, you are required to determine whether an employee’s request does in fact meet the definition of an immediate and necessary expense and keep proper documentation of your decision.   

After the determination is made that an expense is an immediate and necessary expense, a Plan Sponsor must also determine if the employee has any other resources to satisfy this expense. If an employee has other resources available to help meet this expense, generally the Plan Sponsor should deny the hardship distribution request.  In certain circumstances the law includes assets of the employee’s spouse and minor children when defining “other available resources”. Hardship distributions should be utilized only as a last resort to satisfy expenses for the employee.  As the sponsor, you may rely on the employee’s representations relating to other resources unless you have actual knowledge to the contrary.

Another requirement that should be considered prior to approval of hardship distributions is there are other forms of distributions from the plan or available loans.  As a Plan Sponsor, you must determine that there is no other form of distribution available to the participant prior to approval of hardship distributions. You should also verify that the hardship distribution amount requested does not include more than an employee needs to satisfy the immediate and necessary need. This can be determined based on the documentation provided by the employee while determining that there is an immediate and necessary need. The IRS has cited record keeping of documentation for approval of hardship distributions as commonly neglected.

It is generally good practice to discuss with the employee prior to a hardship distribution the consequences of taking the distribution. They may have various penalties and taxes to pay depending on their situation. These penalties and taxes can be added into the hardship distribution amount in order to help the employee pay for the expense plus the penalties and taxes.

If the Plan Document allows for hardship distributions, have procedures in place in order to approve or deny the distribution request. These controls are imperative to help you as the Plan Sponsor consistently determine if the hardship distribution requests are valid.

Shelby Williams

Providing a 401(k) plan for company employees is a valuable benefit for them.  The benefit to the Company is hopefully that it attracts and retains valuable employees.  The cost to the Company on the surface might appear to just be fees paid to service providers who help administer the plan such as hold plan investments, prepare participant and plan accounting, provide advice regarding plan investments options and ensure plan compliance with regulations.  However if operational failures occur, fees, not originally anticipated when the plan was created, can arise.  As plan trustee, it is important to know all options available to correct for operational failures in order to avoid these “hidden” fees.

Costs associated with fixing an operational failure fall into two groups; first, the cost to correct the error, second the cost to report the error to the IRS.

Some corrective actions can be completely free to the plan sponsor.  Some corrective actions costs will consist mostly of administrative costs.  For example costs to amend the plan document for updates required by law changes, or refund excess contributions to participants that exceeded 415 limits or caused the plan to violate ACP/ADP discrimination tests.  However sometimes corrective actions can be costly.

Like corrective action costs, costs to report the error to the IRS range from free to very costly.  The Correction programs provided for by the IRS (assuming that the plan is not under audit) are the self-correction program (“SCP”) and the Voluntary Correction Program (“VCP”).  The SCP is free.  However, the operational failure must meet certain criteria in order to qualify under the SCP.  If the failure does not qualify under the SCP, then the plan must submit the corrective action under the VCP and pay a fee based on the number of participants in the plan (up to a maximum of $25,000).

In order to qualify for the SCP the following must be complied with
• The failure must be an operation failure, accordingly the error was a failure to comply with the plan document
• The error occurred despite the plan having established practices and procedures in place to prevent the error
• The failure was corrected timely, within two years of the end of the plan year in which the failure occurred or the failure was not significant
• The failure was corrected using the principles set forth in Rev. Proc. 2008-50
• If needed, the plan sponsor effects changes to practices and procedures to ensure the failures don’t occur again
• Documentation of this correction and it qualification under the SCP is maintained

Following is an example of a compliance failure that, because of how it was handled, ended up costing the sponsor significantly more costs to correct.

Company A’s 401k plan failed the ADP/ACP discrimination testing in year XXX1.  The testing was properly performed by the Plan’s third party administrator and notified the Company of the excess contributions that should be made to certain highly compensated participants in order to pass the ADP/ACP test.  If the Company had made this reimbursement, the plan’s compliance deficiency could have been corrected without any cost to the Company.  However, the Company did not instruct their administrator to make the needed refunds.  In year XXX3, it was determined that the excess refund contributions had not been made.  Accordingly, the time period allowed to correct for the discrimination failure by making contribution refunds had passed (12 months after the plan year-end is the allowed time period).  The only option available to the plan was for the Company to make qualified non-elective contributions (QNECs) to non-highly compensated employees.  These QNECs, totaling more than $30,000, were additional contributions required to be made by the Company.  Additionally, if it is determined that the mistake was significant or that the plan did not have practices and procedures in place to ensure compliance, then the plan would not be eligible for the SCP correction program.  Accordingly, the deficiency would have to been reported to the IRS under the VCP and applicable fees totaling $5,000 (the plan had between 101 and 500 participants).  In addition to the fees paid to the plan and the IRS, the sponsor incurred additional fees from the administrator.  So instead of a simple refund of excess contributions by the plan, that would have cost the Company nothing, the Company ended up paying more than $40,000 to correct for the compliance deficiency. 

Avoid costly compliance failure costs by proper and timely administration of plan compliance requirements.

Kim Lubbers, CPA