According to the Internal Revenue Service, 401(k) plans represent the largest retirement plan market segment in the U.S., comprising more than 60 percent of all retirement plans. Further, 401(k) plans are by far the most noncompliant type of retirement plan.
In an effort to focus enforcement efforts and understand noncompliance, the IRS initiated a compliance check project of 1,200 randomly selected 401(k) plan sponsors that were required to complete an online questionnaire. The agency intends to use the responses to redesign their audit case selection process and develop follow-up compliance projects to address identified issues and trends.
The IRS believes internal controls and annual reviews are essential in maintaining retirement plan compliance. In fact, having effective practices and procedures to prevent compliance problems is a basic requirement to be eligible to use the IRS’ self-correction program – which permits the self-correction of insignificant operational errors at any time, without having to pay any fees to preserve the tax-favored status of the plan.
When auditing a plan, the agent will typically first evaluate the effectiveness of the plan’s internal controls to determine whether the audit can be focused on a few issues or if the audit scope needs to be expanded. There are a number of best practices that should be implemented to not only ensure plan compliance but also minimize the time and expense in the event the plan is subject to audit.
Always review your plan document for law changes. You must maintain the plan document, amendments, adoption agreement (if any), summary plan description, any opinion, advisory or determination letter issued by the IRS, and all corporate resolutions/minutes related to the plan. You should be clear about who is responsible for reviewing and updating the plan terms.
Normally, you will want to maintain contact with the company that provided the plan document, and you should check with them a couple of months before year-end to confirm whether changes are required. Make sure you understand the applicable deadlines and act timely when implementing changes. When you make a change to your plan document, it might be necessary to also make corresponding changes to the summary plan description, and you should communicate the changes to plan participants.
There are a number of common plan administration errors that can be avoided. Make sure to review the plan’s definition of compensation and verify the accuracy of participants’ payroll records with regard to compensation, hours of service and dates of birth, hiring and plan participation. If the plan permits loans, review the plan’s loan provisions and verify the loan application, approval, disbursement and repayment procedures. Review the plan participant distribution forms to ensure they properly reflect the options available under the plan. Review the procedures for participant withholdings and/or contributions. Review the procedures for nondiscrimination testing and compliance with annual addition limitations. Lastly, compare the requirements under the plan with the procedures for the timely deposit of elective deferrals.
If you have adopted a preapproved plan provided by a third party, review your service agreement to understand your responsibilities and those of the pre-approved plan sponsor. Answer these questions:
- Who is responsible for updating the plan document for any law changes?
- Who will administer the plan – the pre-approved plan sponsor or a third party?
- Who gives any required plan notices to the participants?
- Who files required forms and returns with the IRS or U.S. Department of Labor?
- Where will the plan accounts be maintained? What are the fees for those accounts?
- How will the funds be invested? What are the fees associated with the investments?
- If something goes wrong and the plan becomes noncompliant, how will the plan be brought back into compliance and at what cost?
- What information do you have to give to the preapproved plan sponsor or administrator and when must you provide it?
- What other services are you entitled to under the agreement? An annual compliance check?
While this is by no means a simple undertaking, an ounce of prevention is worth a pound of cure definitely applies to keeping retirement plans tax-qualified.
Richard Russell is a financial services attorney in Husch Blackwell LLC’s Springfield office. He can be reaced at richard.russell@huschblackwell.com.
