When an employer adopts a 401(k) plan, there are many important considerations that it must keep in mind. A recent blog entry discusses key matters an employer should consider.
In “Just Adopted a New 401(k) Plan? Beware These Common Pitfalls,” an entry in the E is for ERISA Blog, Christine P. Roberts, an ERISA benefits attorney with Mullen & Henzell L.L.P., discusses potential pitfalls and things a business owner should avoid.
Top-Heavy Status
A plan can be top-heavy in its first year, warns Roberts; she says it is more common for that to happen because long-term key employees’ large account balances accumulated. It is especially likely, she adds, that a plan will achieve top-heavy status if it is run by a family-owned business, as family members of owners count as key employees.
ADP/ACP Testing
It is possible for there to be a failure of the actual deferral percentage (ADP) test, which occurs when the average rate of elective deferrals highly compensated employees (HCEs) make exceeds the average rate of elective deferrals made by non-HCEs by more than a permitted amount, Roberts notes. She adds that a related test applies to matching contributions—the actual contribution percentage (ACP) test.
Elective Deferral Deposits
There is a deadline by which payroll and pull employee elective deferrals must be invested under the 401(k) plan; at that point, they are considered to be plan assets under ERISA, notes Roberts. She adds if one does not meet the seven business-day or “as soon as” deposit deadline, retaining employee funds is a prohibited transaction and will result in (1) having to pay excise taxes to the IRS and (2) a fiduciary breach for purposes of the Department of Labor (DOL).
Plan Audits
A business sponsoring a new 401(k) plan may be required to obtain an audit report prepared by an independent qualified public accountant on the plan’s operations and finances. Such reports generally are required for plans with 100 or more participants as of the first day of the plan year—and that includes those who are eligible to participate regardless of whether they actually do. And, Roberts adds, plan sponsors have additional responsibility to account for plan operations and documentation under auditing standards that go into effect this year.
Action Steps
Roberts suggests some steps that an employer can take to avoid these problems.
Adopting a safe-harbor 401(k) plan design as a safe-harbor matching or non-elective contribution will satisfy minimum top-heavy contribution requirements, Roberts says. She adds that SIMPLE-IRA plans also are exempt from top-heavy requirements, as long as there are no more than employees.
One can better avoid an ADP/ACP testing failure, says Roberts, by using:
- a safe harbor contribution formula;
- a top 20% election to define highly compensated employees;
- automatic enrollment at a meaningful percentage of compensation (such as 5% or higher); and
- enrollment meetings and other tools to engage employees.
And if ADP/ACP testing failures have occurred, correction steps will incorporate refunding amounts to HCEs or making additional contributions to non-HCEs.
If late deposits of elective deferrals have taken place, says Roberts, it is possible to seek relief from the excise tax and from potential fiduciary liability by participating in the Department of Labor’s Voluntary Fiduciary Compliance Program or VFCP. And, she adds, complying with applicable deposit deadlines is a way to avoid late deposits and the need to disclose them.
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