Many employers and retirement plan sponsors mistakenly believe that having a third party manage their retirement plans means they can relinquish their responsibility for the plan. That’s a dangerous assumption, and they’re wrong. Ultimate responsibility for a retirement plan lies with the plan sponsor, who must make sure it functions well for employees and complies with Internal Revenue Service (IRS) and Department of Labor (DOL) guidelines.
Plan sponsors and employees get the most from their retirement plans when they maintain their qualification status – that is, they remain in compliance with IRS guidelines and retain tax and other benefits. Because retirement plan management is a complicated business, however, it’s easy for mistakes – often referred to as retirement plan failures – to be made. Even the seemingly smallest mistakes must be corrected or a plan is subject to IRS disqualification, leaving plan sponsors and employees potentially subject to significantly increased taxes on funds invested in the plan.
Common plan failures
Even though this is not an exhaustive list of failures, these are seven of the common ones that I have seen over the course of my career:
- Not consistently defining “compensation.” One of the main focus areas of IRS retirement plan audits examines whether the way the plan document and/or summary plan description defines “compensation” is consistent with how the plan is actually administered. For example, payroll codes are often inconsistent with the plan document’s definition of compensation – especially at larger corporations with different payroll systems.
- Having an out-of-date plan document. Plan documents are living documents, in need of continuous updating as needed over time. Sometimes, the updates are required by tax law changes; other times, the updates are necessitated by discretionary changes made by the employer. Regardless of the reason for the change, the important thing is that the plan document is current with all of the proper forms and signatures. It’s also important that any changes are accurately reflected in the summary plan document and the proper notifications are sent to plan participants as needed.
- Not following the plan’s eligibility or enrollment rules. With employees continuously joining, leaving, and changing status in an organization, it’s easy for them to be wrongfully included or excluded from a company’s retirement plan program. Even so, it’s important that these errors are identified and properly amended as soon as possible; just one misclassified or excluded employee is enough to cause negative consequences if left uncorrected.
- Failing to make changes in deferrals. Plan administrators must be careful to make deferral changes consistent with the terms of the plan. For example, if a plan states that employees may make deferral changes that will go into effect during the next pay period, then that is when the changes should be made. Not doing so would be a failure and could put the plan at risk for disqualification.
- Incorrect use of forfeitures. Forfeitures – which are typically an employer’s matching funds that employees leave behind when they leave an organization before they are fully vested – must be handled according to the plan document. Any use outside of what the plan document outlines is considered a failure.
- A lack of nondiscrimination testing. The IRS requires that most retirement plans not classified as “safe harbor” undergo actual deferral percentage/actual contribution percentage (ADP/ACP) testing annually. This testing ensures that all participants are benefitting fairly from the plans. Not only should the testing be conducted annually, but the results should also be analyzed and documented.
- Vesting failures. These types of failures can result from employees with breaks in service, inter-company transfers, acquisitions, terminations and partial terminations. Plan sponsors are responsible for making sure that employees are properly vested according to plan documents.
The good news is that most plan failures can be corrected using the methods outlined by the IRS and/or the DOL. The key is to identify the failures as soon as possible and then apply the appropriate fix to make things right.
If you would like to learn more about retirement plans, contact Brad Bechtel using the information below.
Senior Vice President
Employee Benefit Services
Brad Bechtel leads AGH’s employee benefit services (EBS) division, which serves clients nationwide. EBS is one of the region's largest providers of retirement plan recordkeeping services for daily valuation plans. The division provides consulting services to clients on employee benefit plans including plan design, implementation, operation, fiduciary due diligence, compliance, and through affiliate AGH Wealth Management, discretionary and non-discretionary investment fiduciary services, investment advisory services and employee education.
Bechtel is experienced in executive compensation, including non-qualified, phantom stock, top hat, and excess benefit plans as well as other deferred compensation approaches. He has consulted for numerous Fortune 500 corporations on investment management and fiduciary due diligence. He also provides search and selection due diligence consulting services for companies seeking new investment and recordkeeping providers for their qualified plans. Bechtel is a registered investment advisor who holds Series 7, 24, and 66 FINRA registrations, and he is a member of the American Society of Pension Professionals & Actuaries.