Plan sponsors who fail to meet deposit timing requirements for employee deferrals and loan repayments to retirement plans may be subject to additional taxes. Here’s what you need to know about finding and correcting this potentially expensive problem.
One particular rule applicable to 401(k) plans relates to when participant contributions are considered to become plan assets. If a plan sponsor doesn’t deposit the participant contributions within the prescribed time frame, the law treats those withheld amounts as “loans” from the plan to the plan sponsor. Such loans are considered prohibited transactions under the IRS and ERISA rules. The fines, interest, and other penalties related to late and/or incomplete deposits can accumulate quickly for a plan sponsor. The good news is that if errors do occur, programs exist to assist plan sponsors with correcting them.
The good news is that if errors do occur, programs exist to assist plan sponsors with correcting them.
How to identify late deposits
If you’re wondering whether your retirement plan has late deposits, the first thing you need to know is which deadline applies to your retirement plan:
- Small plans, those with less than 100 participants, have a safe harbor deadline of seven business days after the pay date to deposit the amounts into the plan.
- Large plans are those that have 100 or more participants. The rules require that plan sponsors of large plans deposit deferrals and/or loan repayments into retirement plans “as soon as administratively feasible” but in no event later than the 15th business day of the month following the payroll withholding. Not having a specific timing requirement like small plans can make it difficult for large plan sponsors to know when contributions are “late.”
Regardless of plan size, the plan sponsor should perform a thorough analysis of payroll information, comparing it to the retirement plan trust deposit records to confirm that each deposit was calculated correctly and deposited “timely.” It’s common for plan sponsors to engage an outside party to perform such an analysis in order to have an independent set of eyes involved in the process.
Correcting late deposits
If late deposits are identified, the plan sponsor must take the following steps to correct the error:
- First, deposit any outstanding contributions. This step is necessary in the event the plan sponsor failed to deposit any required deferrals and/or loan repayments that were previously withheld from pay. Any amount that was withheld from a participant’s pay but has not yet been deposited into the plan must be contributed to the participant’s retirement plan account as soon as possible.
- Second, review previously deposited amounts to ensure they were made timely. Determining whether a deposit is made timely is a facts-and-circumstances exercise, but a good rule of thumb is that if you have amounts that were deposited more than two to three days after the payroll date, you likely have untimely deposits.
- Third, calculate and deposit lost earnings. Once the plan sponsor has deposited all deferrals and/or loan repayments into the plan and determined any other amounts that were deposited late, lost earnings must be calculated and deposited into each affected participant’s accounts. The lost earnings can be calculated using the plan’s actual rate of return or by using the DOL’s Voluntary Fiduciary Correction Program (VFCP) calculator available on the DOL’s website.
While making participants whole is the first step in correcting the error, the following filings correct the late contribution prohibited transactions with the IRS and DOL:
- File an IRS Form 5330, Return of Excise Taxes Related to Employee Benefit Plans. This return calculates the excise tax that a plan sponsor owes related to the lost earnings that resulted from late deposits. It’s required for tax years beginning in the year the error first occurred and for every subsequent year up to and including the year the lost earnings are deposited.
- Report late contributions on Form 5500 and in audited financial statements. The plan sponsor’s Form 5500, Annual Return/Report of Employee Benefit Plan, as well as any audited financial statements, should disclose any late contributions. As with the Form 5330 above, disclosure is required for plan years beginning in the year the error first occurred and for every subsequent year up to and including the year the lost earnings are deposited.
- Participate in the DOL’s VFC Program. The DOL’s VFCP is designed to encourage plan sponsors to voluntarily self-correct certain plan violations. While filing the Forms 5330 and paying the excise tax corrects the prohibited transaction with the IRS, filing an application under the VFCP facilitates correction with the DOL. It’s important to note that this program is voluntary; however, its use is strongly encouraged by the DOL.
Sooner is better
If you have questions about your business’s retirement plan compliance, it’s best to resolve them before the IRS or DOL contacts you about potential problems. If you would like to learn more about how to resolve potential issues caused by late contributions to retirement plans, please contact a Plante Moran employee benefits consultant.
If you have questions about your business’s retirement plan compliance, it’s best to resolve them before the IRS or DOL contacts you about potential problems.