When it comes to Participant Deferrals - Fiduciaries Beware - Don't Be Late
A greatly misunderstood aspect of the United States Department of Labor’s (DOL) and Internal Revenue Service’s (IRS) rules and regulations, by employers of all sizes, relates to the timeliness of the remittance of participant contributions into contributory employee benefit plans, including 401(k) plans. The guidelines are strict and violation is constituted as a prohibited transaction (a direct or indirect transaction between a plan and a party in interest) as the employer is accused (and guilty, even though usually not intentionally) of using participant funds for its own use. This is a breach of fiduciary duty and is not a situation in which plan fiduciaries wish to be found.
The general rule, as set forth in 29 CFR 2510.3-102, states that employee deferrals must be remitted to the Plan as of the earliest date on which the contributions can reasonably be segregated from the employer’s general assets. The regulations also provide that in no event shall the funds become Plan each pay period is not available after only a few business days, if not simultaneously with the issuance of paychecks. Certainly, it is understandable that details must be in order prior to transferring funds to the custodian. It is, however, the DOL’s view that those details should not cause significant delays in processing and forwarding employee deferrals.
Prohibited transactions, including late deferrals, continue until corrected, and both IRS and DOL penalties apply. Self-correction, which includes “bringing participants whole” by depositing the late deferrals and the lost earnings applicable during the time the employer held the participants’ funds, is a widely used form of correction. Employers are often surprised to find that, even in a time of plan losses, plan earnings are due. The amount of lost earnings is then based on the benefit received by the employer from the use of the participants’ funds or a rate published under Internal Revenue Code Section 6621(a)(2). The IRS contends that correction is not complete until the 15 percent ex- cise tax on the earnings is paid along with Form 5330.
This is such an important concern that the 2002 Form 5500 has been modified to further impress the issue and make it clear that the so-called 15 th business day rule is not a safe harbor. Schedules H and I of Form 5500 include a question (Part IV, question 4a on Schedule H) that inquires whether the employer failed to transmit any participant contributions within the regulatory time period. This differs from the question on the 2001 Form 5500 where it queried whether deposits were made within the “maximum” time period. It should also be noted that participant loan repayments paid to or withheld by an employer for purposes of transmittal to an employee benefit plan are subject to the same timeliness guidelines as employee deferrals.
Careful scrutiny should be applied in answering these questions on Form 5500. Strict penalties (imprisonment and/or monetary) apply for making any knowingly false statements or representations of fact, or for knowingly concealing or not disclosing any fact required by the Employee Retirement Income Security Act (ERISA) on the Form 5500. The Sarbanes-Oxley Act of 2002 recently increased these criminal penalties.
For Plans required to have an audit by an independent certified public accountant, generally those with more than 100 eligible participants at the beginning of a plan year, ERISA requires material and immaterial prohibited transactions to be disclosed in the plan’s audited financial statements and supplemental schedules. Thus, even small delinquencies cause action by plan auditors.
Reporting of the prohibited transaction is also made on Schedule G, Part III of Form 5500. This reporting is required each year until the transaction is cured.
As an alternative to the self-correction described above, the DOL has instituted the Voluntary Fiduciary Correction Program (the “Program”). The Program is designed to encourage self-correction of certain prohibited transaction violations of ERISA under prescribed guidelines. Delinquent participant contributions are a covered transaction under the Program. Full compliance with the Program will result in the DOL’s issuance of a No-Action Letter and no assessment of civil monetary penalties under Section 502(l) of ERISA.
The Program generally requires a specific method of self-correction, deposit of lost earnings, and payment of any applicable monetary sanction. To apply, no consultation or negotiation with Employee Benefits Security Administration (EBSA) is required. The procedures are outlined in a notice published in the March 28, 2002 Federal Register. The DOL’s website contains additional information.
Correction is made in four steps:
- identification of any violations and conclusion that the transaction is a covered transaction under the program
- following a specific correction process
- calculation and restoration of funds with interest
- submission of an application and supporting documentation with the appropriate EBSA regional office, including attachments showing corrected financial transactions
After these requirements are satisfied, the employer may treat the prohibited transaction as an exempt transaction and answer “no” to the question on Schedule H or I and no Schedule G is required. In many cases, the prohibited transactions caused by delinquent participant contributions are self-corrected, disclosed on Form 5500, and the applicable excise tax paid since the tax on the lost earnings and cost to file the Form 5330 are often not as substantial as the costs of compliance with the specific requirements of the Program.
Further, full compliance with the Program will provide relief from the IRS prohibited transaction excise tax under Section 4975(a) and (b), provided applicants comply with certain conditions of Prohibited Transaction Exemption 2002-51. The conditions are:
- the contributions must be deposited in the plan no later than 180 days following the date withheld
- the plan sponsor receives a No-Action letter from the DOL under the Program
- the plan sponsor delivers notice to “interested persons” within 60 calendar days following the date of the Program application. Plan assets may not be used to pay for the notice. Interested persons include participants and beneficiaries. The notice must detail the late deferral and how it was corrected. Also, it must allow these persons 30 days from the date the notice is distributed to provide comments to the DOL
- a plan sponsor may only utilize the exemption once during any three-year period
In cases where there is great difficulty in timely depositing the deferrals due perhaps to multiple locations, multiple payroll systems, etc., Plan sponsors should consider opening a bank account, in the Plan’s name, in which to deposit funds upon withholding from participants’ pay. Once all the details are organized and the information is in the proper format to transmit to the custodian, the monies can be wired/disbursed from this bank account. This enables the participant funds to become plan assets much sooner than if the funds are held in a Plan sponsor’s bank account. Of course, funds generally should not remain in this account for extended periods of time as they should be allocated to the investment choices selected by the participants.
Timely remittance is certainly a process of which every fiduciary should be aware, and in turn should place written policies and procedures. These guidelines will serve to set a framework for employees responsible for deferral remittances and should serve to prevent deviations from the policies and procedures. These must be monitored by the Plan fiduciary on an ongoing basis. ERISA Section 405 provides for co-fiduciary liability and, in particular, Section 405(a)(3) notes that a fiduciary shall be liable for a breach of fiduciary responsibility of another fiduciary if there is knowledge of a breach by the other fiduciary unless one makes reasonable efforts to remedy the breach.
What does this mean to those involved in an employer’s Plan management and recordkeeping? ERISA includes detailed fiduciary standards. These include undivided loyalty and the requirement that duties must be discharged with care, skill, prudence, and diligence. Conflicts of interest and prohibited transactions must be avoided. Fiduciary responsibilities include acting exclusively in the interest of the plan participants and beneficiaries. Care must be taken by fiduciaries in every aspect of their actions and decisions regarding the Plan.
There is a tremendous misconception by those acting as fiduciaries that they are not, in fact, fiduciaries. There is a lack of understanding of what responsibilities and potential liabilities such a designation entails. Fiduciary status is determined functionally by authority or control, not by title. A fiduciary that is also a corporate officer of the Plan sponsor is not absolved from the fiduciary obligations to the Plan participants and beneficiaries. All actions as a fiduciary should be documented and quarterly committee meetings of Plan fiduciaries are recommended along with minutes for each.
In conclusion, it cannot be impressed enough upon Plan fiduciaries the importance of their designation and the importance of the timeliness issue. As noted herein, policies, procedures, and controls regarding deposits into employer sponsored plans should be in place and strictly adhered to. Those employers with payroll dates on the 15th and 30th of each month, or weekly, etc., that now remit the participant deferrals consistently by the 15th business day of the month following those pay dates need to take a close look at how other payroll deductions are transmitted to determine reasonable segregation dates for their particular circumstances and take action to deposit the deferrals into plans on a more timely basis. Proactive fiduciaries will review current deferral deposit procedures, assure proper documentation of procedures exists, and continually review procedures to assure they remain in place and effective, and seek assistance in this area where necessary.