401(k) Plan Sponsor Pitfall #3: Employee Contributions
Amy Sac, CPA | July 17, 2018
The 15th day rule is the most common rule followed by employers when remitting their employees contributions to their 401(k) plans. This rule tells an employer that it can make deferrals to the plan no later than the 15th business day of the following month. However, most employers don’t know that the law also states that contributions to the plan should be made, “as of the earliest date on which such contributions or repayments can reasonably be segregated from the employer’s general assets.” These seemingly contradicting rules lead to the largest misconception and violation for most employers. The Department of Labor (DOL) does give you until the 15th business day of the following month to remit contributions to the plan, but if these contributions can be remitted earlier, they should be.
The easiest solution for an employer is that it should always deposit the employee’s contributions into the 401(k) plan as soon as possible. For many employers, this means remitting the deferrals the same day payroll is processed. This needs to be done as quickly as it can, or it may become a prohibited transaction according to the DOL. The problem employers run into is what exactly the DOL will classify as a prohibited transaction. A typical example of a prohibited transaction is a contribution to the plan that is made in different increments after each payroll period. Let’s say a company runs payroll on the 10th and the 25th of every month, they are usually remitting around $25,000 per pay period, and their timeliness of contributions has a wide range. Their year to date is shown below:
Their year to date is shown below:
What comes as a surprise is that every pay period, except for the September 10th pay period, is now considered a prohibited transaction, because the employer made the contributions to the plan on the same day as payroll, the DOL sees that as the "earliest date" in which contributions can, and should, be remitted to the plan. Now having committed a prohibited transaction in 23 out of 24 pay periods, the DOL requires the employer to calculate lost earnings for their employees during all 23 pay periods. Luckily for employers, the DOL offers the Voluntary Fiduciary Correction Program (VFCP) calculator for lost earnings. Using this calculator, you will enter the principal amount for each month, the date contributions should have been remitted to the plan, the date contributions were remitted, and the date the profits are paid to the plan.
Below is an example of this Company's results using the lost earnings calculator:
In this example, the problem was caught and profits were remitted to the plan on August 1, 2017. The Employer (Plan Sponsor) now owes $1,442.13 in lost earnings just for 2016, and it will need to make this payment to its plan to comply with the DOL.
As you can see, timelines of contributions can spiral out of control quickly if the employer does not manage them correctly. Proper understanding of a company's ability to remit employee's contributions, educating persons charged with management of plan contributions, and monitoring the remittances will help an organization's 401(k) contributions run smoothly.
Contact us today if you need help with your 401(k) audit.