Plans break operationally from dozens of causes, but without regard to cause, these are the most common failures continually detected by the Internal Revenue Service (IRS) and Department of Labor (DOL).
Plan failures according to the IRS
The IRS is concerned with the tax-treatment of retirement plans and established the rules to ensure that employers meet minimum requirement to receive the enhanced tax treatment. In December of 2019, the IRS reported their Top Ten Failures in Voluntary Correction Program.1
Each tax law change inevitably carries mandatory provisions to your retirement plan. Sponsors should consider working with external counsel to ensure the plan always carries the appropriate plan amendments.
How much compensation an employee receives is less straight forward than it seems. Payroll employees and systems must be trained and coded to comply with the compensation definition used by the plan.
All employees are not created equal. Plans determine whether an employee is eligible to contribute or receive benefits by hours or job classification.
Allowing participants to borrow from their retirement savings is common but fraught with errors. Plans that allow for participant loans must have mechanisms in place to address participants who fail to repay their loans.
Generally, the tax benefits of retirement plans are in exchange for a commitment to use the proceeds for retirement. Over the years, tax policy and plan design have led to more plans with distribution options for current employees. These rules must be understood and followed.
The economic value of the tax benefit is one of the largest tax incentives in the Code. In exchange for avoiding taxation at the time of contribution, plans require that participants who are no longer employed begin taking distributions when they attain a specific age (generally 72). Plans must enforce that eligible participants begin distributing benefits and paying taxes on the distributions.
This just means that you can only sponsor the type of plan your business structure is eligible to sponsor.
In exchange for favorable tax treatment, the IRS requires that plans be tested to ensure that too much of the economic benefit is not passed to highly-compensated employees. Well-designed plans are generally structured in such a way to dramatically reduce (or eliminate) the risk of failing a nondiscrimination test. Furthermore, plans that fail their nondiscrimination tests have a number of remedies to bring the plan into compliance.
This is a secondary form of the compliance test. If you have more than 100 employees, your top-heavy test will never be an issue.
No matter who you are and how much you make, the law limits the number of contributions a participant can receive in a defined contribution plan. These limits are indexed to inflation and need to be accounted for in your payroll process.
While the list is long, elite retirement plans establish accounting and human resources procedures to avoid these errors and governance for the continual review of these issues.
Plan failures according to the DOL
The DOL’s concern is the protection of plan participants. Much like the IRS, they regularly report on the primary failures they see in retirement plans.
Most defined contribution plans include employee deferrals as a feature of the plan. Once money has been deducted from an employee paycheck, it needs to quickly be incorporated into the plan.
In an effort to create transparency for the retirement plan participants that rely on these plans, the DOL requires that a number of disclosures are provided to participants regularly. While there is little data to support that these disclosures have helped participants better understand or utilize their retirement plans, there are risks to sponsors that fail to provide them.
The bond generally insures the plan against theft by a person who handles plan assets (think your payroll clerk). These bonds are inexpensive but required; routinely sponsors neglect to purchase or renew their bond.
Every retirement plan has a published claims process. These processes articulate what steps a participant must take if they feel their rights under the plan have been violated. While claims should be rare, employers must understand what qualifies as a claim and the steps they must take if a claim is received.
The Employee Retirement Income Security Act (ERISA) requires that plans be maintained in the best interest of the plan participants and their beneficiaries. The DOL is highly-concerned with potential conflicts where money from the plan (fees or investments) are used in ways that benefit the employer and not the employees.
In most plans, the fees for services pertaining to a defined contribution plan are paid by the employees, not the sponsor. As a result, the plan has an obligation to ensure that plan costs are monitored closely and that participants are paying only reasonable fees.
Like their IRS kin, the DOL regulations require processes and training. They are critical to creating the foundation of an elite retirement plan.
Read our Guide to Climbing the Ladder to an Elite Retirement Plan for our in-depth look at running the best retirement plan possible.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.