Although The Department of Labor (DOL) published final regulations on January 14, 2010 (and effective on that date) providing "safe harbor" rules governing timely deposit of employee 401(k) contributions, we continue to come across instances where the deposit rules are not properly applied. According to the DOL, timely employee contributions continue to be a chronic problem. Since 2000, about ninety percent (90%) of the applications filed under the Voluntary Fiduciary Correction Program have involved delinquent participant contributions.
Note that the 7th business day safe harbor only applies to small plans (i.e., less than 100 participants) and the "as soon as can be reasonably segregated (but no later than the 15th business day of the month following)" continues to be the rule for large plans, the plans with more than 100 participants that require an audit. Our experience has been if large plans demonstrate that they can segregate the funds in, for example, 3 days, then any remittances in excess of 3 days would be deemed late.
Illustration of 401(k) deposit deficiency and correction procedure
Company X sponsors a 401(k) plan with 25 participants with semi-monthly pay dates of the 15th and 30th of each month. Each payroll period has a total of $3,000 in employee 401(k) deductions withheld from employees' pay. For the full 2012 plan year, Company X misinterpreted the ERISA requirement for timely depositing of employee 401(k) contributions and, as a result, was making the deposits on the 15th of every month for the previous month's deductions.
In early January 2013 upon an internal audit, it was discovered that the company should have been adhering to the 7th business day safe harbor rule in determining the latest date that the employee contributions were to be deposited to the plan to be considered timely. Company X begins to implement the safe harbor rule commencing with the January 15, 2013 pay date. But how does the Company now retroactively correct the contributions that were deposited late during all of 2012? The answer is through the Department of Labor's Voluntary Fiduciary Correction Program (VFCP).
Company X decides to participate in the VFCP as a corrective measure. The first step is to calculate the lost earnings associated with each payroll's late 401(k) contributions. To assist in these calculations, the Department of Labor provides an on-line calculator as part of the VFCP.
The following variables are entered into the calculator for each 2012 payroll to calculate the lost earnings:
- Principal (amount of 401(k) employee contributions)
- Loss Date ( 7th business day following the pay date)
- Recovery Date (actual date contributions were deposited)
- Final Payment Date (date lost earnings are deposited)
The total lost earnings are calculated to be $77.61. Company X deposits the lost earnings to each affected employee's 401(k) account on January 15, 2013, the Final Payment Date chosen in our example.
This then brings Company X to the point where they are ready to submit a formal application through the VFCP to identify the failure and the steps that were taken to correct it. Company X provides a narrative explaining how the failure was discovered and what changes have been made within the company's internal controls to avoid the same failure from reoccurring. Supporting documentation is submitted as part of the application, identifying each affected payroll, how the lost earnings were calculated, and confirmation of the lost earnings being deposited to the employees' 401(k) accounts.
Company X anticipates that, as a result of a successful VFCP submission, they will receive from the Department of Labor a "no-action" letter stating that no further action will be taken by the Department of Labor with regards to this specific failure and that Company X is exempt from the IRS excise tax imposed on prohibited transactions and the filing of Form 5330 which would have been required to be filed in our example by July 31, 2013.
One could ask, given the seemingly insignificant amount of lost earnings, whether it's worth filing a formal VFCP submission. It's a judgment call many employers are making. They simply deposit the lost earnings to the employees' accounts and pay the IRS excise tax, forgoing the VFCP submission. However, there still remains the risk that the Department of Labor could assess civil penalties against employers who violate their fiduciary responsibilities and engage in prohibited transactions if discovered through a Department of Labor or IRS audit. By filing with the VFCP, the employer is given assurance that no further action will be taken by the Department of Labor or the IRS. The purpose of the correction process is to serve as a deterrent against the untimely depositing of 401(k) contributions and as a safeguard to protect employees' retirement accounts.
If you have questions about the content of this article, please contact David I. Waddington at DWaddington@Friedmanllp.com.