Employee Benefit Plan: The 411

Valuable Information on 401ks, Pensions, ESOPs, Form 5500 Preparation + More

Fees to Fix 401(k) Operational Failures

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