401k Plan “Best Practices”
401k plans, although typically intended to provide a tax-beneficial savings vehicle and foster employee retention and satisfaction, have evolved to require extensive compliance and oversight to remain within the parameters of Internal Revenue Service (“IRS”) and Department of Labor (“DOL”) provisions. At our December CFO/Controller Roundtable, Tim Hilligoss, CPA, MST, Shareholder – International Accounting, Practice Leader for Asia, and Bryan Powrozek, CPA, CGMA, Senior Accountant – SME, facilitated a discussion on 401k plan challenges and best practices, including the following:
- Late remittances – Compliance with the DOL’s timely remittance requirements still proves to be a difficult area for some administrators, citing a lack of coordination between the payroll processor and the Third Party Administrator (“TPA”). The specific rules are summarized here, but in general state that once a sponsor can reasonably segregate deferrals from general assets, any contribution subsequent to that date is considered ‘late’ and lost earnings’ corrections would be required. Most plans can remit within one to seven days. Diligence and coordination among relevant parties must be practiced to remain compliant.
- Participant loans – Loans must be administered in accordance with the IRS and the plan document. Loans issued that do not meet these requirements must be corrected. Loan errors should be discussed and documented in plan meeting minutes. Recommendations to prevent loan errors included requiring a trustee to approve all loans or to stop offering loans altogether.
- Participation and employee changes – Payroll must mirror employees’ contribution decisions, which can be challenging depending on plan provisions. Amendments to limit the enrollment dates or frequency of rate changes (quarterly, for example) can reduce the administrative burden and the opportunity for errors associated with frequent changes.
- Bonuses – Plan documents often spell out specific treatment for this type of compensation, which may be different than how it is administered. Sponsors should read the plan document and review internal control processes to make sure the two are aligned, or a sizable correction could result.
- Rollovers – Procedures should be in place to ensure rollovers are sourced from a qualified plan. This is frequently not performed by the TPA and is the trustee’s responsibility.
Discrimination Testing and Enrollment
Failing tests and alternatives – Small, closely-held businesses tend to have higher discrimination testing failure rates. Although there are acceptable corrections upon failing most tests (for example, making qualified non-elective contributions for the non-highly compensated employees in an actual deferral percentage (“ADP”) test failure), there are ways to prevent failures. Prevention includes:
- Interim discrimination testing to adjust before year end
- Using the ‘prior year’ versus the ‘current year’ testing method, if available
- Adopting a safe harbor plan which requires an employer contribution but lifts the testing requirement
- Creating a separate plan altogether for highly compensated employees to prevent repetitive failures
Another way to reduce testing failures is to increase enrollment, which often can be achieved by the following:
- Marketing – It can be difficult to encourage employees to join the plan. Several sponsors regularly send out enrollment materials and host meetings to highlight the advantages. Pizza lunches or jeans days for attending enrollment meetings can improve turnout.
- Automatic enrollment – Adoption agreements may provide for an election whereby eligible employees are automatically enrolled at a specified rate into a default fund, unless they affirmatively elect otherwise. Some administrators hesitate adopting this feature, fearing employee aversion. Most felt that increased enrollment outweighs the perceived costs.
- Employer matching – Many plans offer a match that is capped at a specified percentage. Discretionary employer contributions can provide a bit more flexibility. Regardless, the consensus was that plan sponsors should consider their budget and potentially benchmark against others in their industry to ensure they remain competitive, while keeping in mind that employer matching can be the single most influential factor driving employee enrollment decisions.
- Audit requirement – Generally, audits are required if at the beginning of the year, a plan has 100 or more participants (includes eligible employees not participating). A special “80/120” provision permits flexibility with this rule when participation levels fluctuate around 100. Sponsors should regularly monitor participation levels – and potential force-outs – to enable proper planning should an audit be required.
- Limited vs. full scope audit – The DOL permits limited audit procedures over investment information if supported by a qualifying certification of investment accuracy and completeness. Participant data, contributions, distributions, etc., are still audited. A full scope audit requires procedures be performed over investments. Some alternative investment platforms, such as self-directed brokerage accounts or guaranteed investments, may not be certified and thus require full scope procedures.
- Audit procedures and standards – While a TPA can provide partial audit support, there is still a great deal of audit requests and testing at the plan sponsor level, particularly regarding internal controls, employee data, and payroll information. The DOL Audit Quality Study revealed a high percentage of deficient plan audits; which further amplifies the need for quality audits. The general belief of the group was that audits will continue to become more rigorous to meet regulatory demands.
- Who is a fiduciary – Named fiduciaries control and manage the plan. Advisory fiduciaries assist in making investment or administration decisions. Providers commonly believed to be fiduciaries frequently disclaim responsibility, so it’s important to read service contracts to understand their ultimate accountability.
- Increased requirements – Recent case law serves as evidence that increased scrutiny over meeting fiduciary responsibilities is a primary focus for both the DOL and federal courts. Fiduciaries can improve processes and documentation to serve as proof of meeting their responsibilities.
- Reasonable expenses – Obtaining benchmarking studies or service provider quotes are practical ways to ensure rates are competitive. Many sponsors shop for quotes every few years and document the final decision to further support the fulfillment of their fiduciary responsibilities.
- IRS and DOL – IRS and DOL examinations are technically random; however, the group generally believed that uncorrected errors and even disgruntled employees could trigger an examination. The self-correction and voluntary correction programs can be useful tools for plan sponsors looking to remedy errors as soon as they become known to further mitigate examination risk. (View a summary of correction methods.)