Common Plan Errors and Best Practices to Avoid Audit Pitfalls

Throughout this presentation, we will discuss the most common errors found in employee benefit plans such as untimely participant deferrals and the improper application of the Plan’s definition of compensation when calculating employee and employer contributions.  These errors are considered operational defects and can cause Plan disqualification if not corrected.  Best practices include reading the Plan document at least annually to ensure that the Plan is operating in accordance with the Plan document and understanding the payroll process to determine and document how soon contributions can be deposited into the Plan. 

There is a common misconception with regard to who is responsible for the Plan.   The Plan administrator is responsible for maintaining the Plan’s tax qualified status and Plan management is responsible for maintaining compliance of the Plan in accordance to the Plan’s provisions.  This includes processes performed by third party service providers.  Plan sponsor’s can outsource certain aspects of the operation of the Plan, but they can never outsource the responsibility of the Plan.

Opening Thoughts?
  • No Plan Is Perfect. Noncompliance happens.
  • Plan Administrator is responsible for Plan's tax qualified status.
  • Plan management is responsible for maintaining compliance of the plan which includes processes performed by third party service providers.
  • Auditors responsibility is to assess the impact of the compliance failure in the context of the financial statement audit.
Audit Objectives
  • Participant Data-The objectives of auditing procedures applied to participant data are to provide the auditor with a reasonable basis for concluding whether:
    • all covered employees have been properly included in employee eligibility records and contribution reports
    • accurate participant data for eligible employees was supplied to the plan administrator (and actuary)
  • Distributions/Benefit payments-The objectives of auditing procedures are to provide a reasonable basis for concluding whether:
    • payments are in accordance with plan provisions
    • payments are made to those entitled to them
    • transactions are recorded in the proper account, amount and period
Focus of our Presentation
  • Fiduciary Duties
  • Exclusive Benefit Rule – to operate the plan for the exclusive benefit of plan participants and their beneficiaries
  • Prudent Man Rule - ERISA 404(a)(1)(B) – with care, skill, prudence and diligence
  • Operate the plan according to the terms of the plan - Operating outside the governing terms can result in disqualification of the plan and breech of duty.
  • Diversified and appropriate investments – to manage the risk of loss of the investments
  • Reasonable plan expenses
Common Errors Noted During A Plan Audit
  • Misconception with regard to who is responsible for the Plan
    • Failure to properly apply the Plan's provisions:
    • Improper application of definition of compensation
    • Improper application of plan's eligibility provisions
    • Improper use of forfeitures/lack thereof in accordance with the terms of the plan
    • Distribution Issues
    • Failure to follow participant elections
  • Untimely participant deferrals and lack of reconciliation of deferrals to deposits into the plan
  • Actuarial census errors/outdated information
Errors – Participant Data Testing
  • Errors are important!
    • Non compliance with the plan document is an operational defect that can cause plan disqualification
  • Careful assessment of materiality at the participant level is imperative
  • Qualitative aspects of materiality
    • Participant contribution errors (i.e. Incorrect compensation base)
      • Could be systematic and impact many participants over many years
      • Making participants whole
      • Operational errors
        • Impact on tax exempt statu
    • Misconceptions with Regard to Responsibility 
  • Know who is a fiduciary and what their roles are - DOCUMENT
  • Know your fiduciary responsibilities
  • Know the essential elements of the plan - DOCUMENT
  • Read the plan document at least annually and anytime you are unsure about a provision in the plan document or when its restated-DON'T GUESS 
  • Plan sponsor is responsible for operating the plan according to its provision 
  • Ensure that the record keeper, trust company, and staff working on the plan are all following written plan document
  • A Plan Sponsor can outsource certain things, but they can never outsource the responsibility of the plan! 
Generally Plan Sponsor:
  • Determines provisions and how to operate
  • Determines investment policy including investment options
  • Authorizes transactions
  • Provides accurate and complete information (e.g. payroll records)
  • Reviews output (e.g. distribution reports, trust statements)
  • Evaluates service providers
Generally Service Provider:
  • Sets up plan on recordkeeping and/or trust systems based on plan provisions and investment options
  • Receives and processes transactions according to instructions, information received and plan provisions
  • Maintains plan and participant records
  • Provides output (e.g. distribution reports, trust statements)
Improper application of definition of compensation- #1

Is the correct definition of compensation being utilized?

  • Eligible Plan Compensation is critical for accurately calculating employee deferrals, employer contributions, ADP and ACP testing and benefit accruals.
  • Know the definition of compensation per the plan document
    • Initial year- full year for participation or from entry date?
    • Is it the same for deferrals, match and discretionary contribution-BE CAREFUL?
    • Do they have to be employed on the last day of the plan year?
  • Verify if it includes bonuses, vacation, overtime, commissions and/or fringe benefits
  • Ensure that the Plan's payroll provider has coded wages properly to match the Plan's provisions and if there are conversions or upgrades with the payroll provider ensure that they are in line with the plan
  • If errors occur, may need to amend the plan and make participants whole and correct prior years
Improper Application of Plan's Eligibility Provisions

Are the appropriate participants given the opportunity to participate at the appropriate time?

  • Typical eligibility requirements
    • Time requirements (immediate, 1 month, 3 months,1 year)
    • Hour requirements (1000 hours)
    • Possible combination of both
  • Entry dates (immediate, 1st of each month, quarter or year)
    • Missed Entry Date – too late
    • Entry allowed too early
  • Different eligibility provisions for deferrals and employer contribution
  • Excluding eligible people into the plan (part time, subcontractors, certain division)
  • Allowing ineligible people into the plan (part time people or excluded class or division)
  • For those not participating, if eligible, were they given the option and were they notified timely?
Improper use of Forfeitures or lack thereof

Are the Plan forfeitures being disposed of in accordance with the plan document?

  • When a participant who is not fully vested in the employer contribution portion of their account leaves the plan, their unvested account balance is forfeited (subject to the break-in-service rules).
    • Must comply with plan document, generally may be used to:
      • Reduce future employer contributions
      • Pay plan administrative expenses
      • Allocated to remaining participant accounts
  • Plan may provide for different treatment for different types of forfeitures (rare)
  • Master Trust – must track by plan
  • Annual allocation is required- forfeitures may not sit unallocated in the plan.
    • Forfeitures must be used or allocated in the plan year incurred
    • The Code does not authorize forfeiture suspense accounts to hold unallocated monies beyond the play year in which they arise.
    • Essentially the balance in the forfeiture account should be zero at least once during the year
  • For forfeitures used to pay unreasonable plan expenses, make the plan whole from Sponsor's assets (see DOL's VFCP updated program REV Proc. 2008-50)

Has the appropriate participant received the correct amount?

  • Any trailing deferrals?
  • Any trailing earnings allocation?
  • Make sure participant account goes to zero
  • Was it timely?
  • Is the vesting correct?
    • Acquired a group of employees that may receive credit for prior service
  • Hardship withdrawal
    • Do they meet the criteria of the plan document? The process can be outsourced but not the responsibility 
Failure to comply with Participant elections

Have you followed the participants instructions?

  • Participant elections drive the contributions, determine where the contributions are invested, which drives plan earnings activity which eventually drives the distribution amount
  • Error in set up of initial participant contribution elections and investment options
  • Failure to follow change of deferral % and investment option changes
  • Failure to restart contributions in subsequent year when they met the prior year limit
  • Failure to set up loan repayments
Untimely Participant deferrals/loans and lack of reconciliation of deferrals to deposits into the Plan
  • Participant contributions constitute "Plan Assets" and an employer is required to segregate employee contributions from its general assets as soon as practicable, but in no event shall the date occur later than the 15th business day of the following month in which amounts are contributed by the employee or withheld from their wages. (not a safe harbor)
  • DOL View – If employer can deposit into plan in one day, then that will be the standard used by the DOL
  • Set a policy, document it and follow it.
  • Small plans (<100 participants) proposed regulation 7 business days
  • Large Plans-…their view is that if you can deposit payroll taxes immediately, you can also do the same for deferrals and loans
    • Large companies are more sophisticated and have more resources
  • Prohibited transaction subject to 15% excise tax (lost interest) under IRC 4975- report and pay it on form 5330
    • Alternate: use DOL's correction program – VFCP (Voluntary Fiduciary Correction Program)
    • Lost earnings must be deposited into the plan and allocated to affected participants
DB Plans - Actuarial Census Errors/Outdated Information

Is the census information that is provided to the actuary by the Plan administrator complete and accurate

In a defined benefit plan, the information used by the actuary in the census determine the contributions required to ultimately fulfill the benefit obligations and to determine the amounts ultimately distributed

  • Incorrect dates –(date of hire or date of birth)
  • Active people left off
  • Terminated employees are still on. Should they be?
  • Participants that have retired & received a lump sum payment are still on census
  • People that are deceased are still on
  • Tips
    1. Review on an annual basis – get a good starting point
    2. Rollforward
    3. On an annual basis – check to ensure participants are in correct bucket (active, term vested, in pay status)
    4. Check for deceased participants
Root Causes of Operational Failures
  • Lack of understanding of plan provisions
  • Lack of oversight
    • Internal and external
  • Dramatic shift in number of individually designed plans to prototype plans (not reading adoption agreement)
  • Pressure on service providers to control costs
  • Turnover
    • At Plan Sponsor
    • At Service Provider
  • Failure to consult legal counsel and hire a quality auditor with EBP experience
  • Ineffective internal controls or NO internal controls (reconciliations)
Best Practices to Avoid Audit Pitfalls
  • Read your plan document at least annually and when you are unsure, refer back to it. Don't guess!
  • Employee contributions – must be deposited into the plan as soon as can be segregated from the company's assets but no later than the 15th business day of the following month – This is not safe harbor! DOCUMENT your policy and then stick to it!
  • When hiring a Service Provider, make sure that they are qualified (financial condition, experience with retirement plans of similar size, how many employee benefit plans)
  • DOCUMENT the hiring process and due diligence
  • Monitor Service Provider
  • Review Service provider performance
  • Read service agreement, if applicable
  • Read any reports that they provide
  • Review fees charged
  • Follow up on complaints
  • Review of SAS 70 of record keeper and or custodian
  • Review the user controls from the SAS 70 report
  • Identify those charged with governance and hold regular meetings DOCUMENT
Tools Available to Assist
  • Employee Benefit Plan Audit Quality Center
    • Website:
      • Includes Plan Advisories for communication and research on plan responsibilities
      • Includes tools for Plan Sponsors
  • Your Third Party Provider
  • Employee Benefits Security AdministrationOffice of the Chief Accountant: 202.693.8360
  • EFAST Help Line: 1.866.463.3278
  • Plan Sponsor Magazine
  • Profit Sharing Council of America (IPS)

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein. 

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