401(k) Compliance Check #2: Avoid Trouble By Depositing Employee Contributions on Time!
This article discusses the deadlines for depositing participant contributions in a 401(k) plan’s trust or custodial account and the process for correcting any late deposits.
In last month’s 401(k) Compliance Check, we discussed the importance of ensuring your 401(k) plan’s designated decision-makers are actually authorized to make plan decisions. In this month’s Compliance Check, we look at another critical issue for employers – the need to deposit participant contributions in the plan’s trust or custodial account in a timely manner, and what to do when they aren’t.
Why is This Topic Important?
As the sponsor of a 401(k) plan, you have a fiduciary responsibility to timely deposit participant contributions in your plan’s trust or custodial account. Failing to do so is a fiduciary violation,1 and constitutes a “prohibited transaction"2 that will likely subject you to an excise tax. Depositing participant contributions with your 401(k) plan on time avoids those headaches.
What Are the Deposit Deadlines?
What’s the “general” rule for depositing participant contributions? Under Department of Labor (DOL) guidance, a 401(k) plan participant’s elective deferrals and plan loan repayments (collectively, participant contributions) constitute plan assets. As a result, a plan sponsor must forward those participant contributions to the plan’s trust or custodial account by the earlier of:
The earliest date the plan sponsor can reasonably segregate participant contributions from the sponsor’s general assets; or
Not later than the 15th business day of the following month.
The 15th business day of the following month outside limit appears, at first glance, to provide plan sponsors with a bit of breathing room for depositing participant contributions. Looks can be deceiving, though, as the DOL focuses on the first part of the deadline – the earliest date the plan sponsor can segregate participant contributions from the sponsor’s general assets – to determine whether participant contributions have been deposited late.
In our experience, the DOL typically finds that larger employers can segregate participant contributions and remit them to their 401(k) plan’s trust or custodial account within 3-5 days after a payroll date. So, the 15th day of the month deadline will only apply where a delay is truly beyond the employer’s control.
The DOL’s determination is based on its review of the employer’s actual deposit history. As a result, if your experienced payroll team and streamlined payroll processes allow you to remit participant contributions to your 401(k) plan’s trust more quickly than 3-5 days, the DOL might determine your timeframe for depositing participant contributions is even more compressed – perhaps 1-2 days after a payroll date. (Talk about no good deed going unpunished…)
Our plan is small – is there any relief for us? Notwithstanding the general rule, if your plan has fewer than 100 participants at the beginning of a plan year, you can take advantage of a special safe harbor rule. Under that rule, participant contributions are deemed to have been contributed timely if they’re deposited in your 401(k) plan’s trust/custodial account within 7 business days of the applicable payroll date. If you satisfy this safe harbor, you’ll be deemed to have deposited participant contributions on the earliest date those contributions could be segregated from other plan assets.
Be careful not to blow the 7-business day safe harbor, though. If you do, the DOL will look at your actual deposit history to determine exactly how late participant contributions were deposited. For example, if, based on your deposit history, you generally deposit participant contributions with the plan within 4 business days of a payroll date, but took 12 business days to deposit contributions after a particular payroll date, the DOL will view the deposit as 8 business days late, not 5.
What about relief for delays due to COVID-19? At the beginning of the COVID-19 pandemic in early 2020, the DOL issued EBSA Disaster Relief Notice 2020-01, which provides relief from DOL enforcement actions for deposit delays “solely on the basis of a failure attributable to the COVID-19 outbreak.” While Notice 2020-01 remains in effect, given the current (hopefully improving!) state of the pandemic and the relaxation of many state and local mitigation efforts, the relief it offers is likely to apply only in rare circumstances.
We Have Late Deposits – What Should We Do?
(Hint: You Better Fix Them)
To correct a late deposit error, you must put the affected participants back in the position they would have been had the error not occurred. That means making additional contributions to the plan to make affected participants whole for any lost earnings they may have missed out on due to the error.
Is there a correction program to fix this error? The DOL’s Voluntary Fiduciary Correction Program (VFCP) permits eligible3 plan sponsors to disclose and correct various fiduciary failures, including late deposit errors.4 If you correct the error according to the VFCP, the DOL will issue you a “no-action letter.” Per the terms of the no-action letter, the DOL will not institute a civil investigation of the late deposit error or impose civil penalties against you in connection with it.5
To participate in the VFCP, you must first correct the late deposit error, then file an application with the DOL describing (among other things) the amount of each late deposit and when it was corrected; the amount of any lost earnings payable with respect to the late deposits and when they were contributed to the affected participants’ accounts; and the circumstances surrounding the late deposits.
You must also provide specific calculations showing how you determined the amount of lost earnings related to the late contributions. To ensure accurate and consistent calculations, the DOL has created an online tool for calculating lost earnings – the catchily-named VFCP Calculator. While using the VFCP Calculator to determine lost earnings isn’t mandatory, the DOL encourages plan sponsors to use the VFCP Calculator when appropriate.
Do we have to file a VFCP application? No – the “V” in VFCP really does stand for “voluntary.” Whether to file an application through the VFCP is a judgment call. Sometimes, if only a few payrolls were affected or the amount of lost earnings is low,6 an employer may elect not to file a VFCP application.
Not participating in the VFCP means you won’t receive a no-action letter from the DOL, though. So, if the DOL were to audit your 401(k) plan and determine your correction of your late deposit error was “not complete,” it could require you to correct the error to its satisfaction and assess additional civil penalties against you to boot.
Given that, even if you elect not to file a VFCP application, you should still follow the VFCP’s protocols to correct your late deposit errors. We also recommend documenting your correction process – a contemporaneous memo in your 401(k) plan’s administration file could help prove to the DOL that you properly corrected any late deposit errors.
Are we done yet? Almost! You also need to file a Form 5330 with the IRS to pay any excise tax related to the late deposit error.7 Like the calculation of lost earnings, there’s no de minimis amount of excise tax for which you can forgo paying the tax and filing a Form 5330.8
The good news is that the excise tax of 15% is imposed on the lost earnings related to the correction of a late deposit error, not on the late deposits themselves. The bad news is that late deposits that aren’t fully corrected before the end of a tax year are treated as late deposits for the next tax year, and will also be subject to the 15% excise tax for that year. As a result, the calculation of the excise tax can be more complicated if the late deposit error is deemed to continue over several years.
Wait - what about our Form 5500? You must report late deposits of participant contributions on your 401(k) plan’s Form 5500 until they’re completely corrected. If anyone in your organization is reluctant to correct what may seem like a minor late deposit error, having to report it on the plan’s Form 5500 year after year may convince them of the need to fix it. You do not want the DOL to become “interested” in your 401(k) plan because of an uncorrected late deposit error.
Note that while the DOL may not consider a late deposit error fully completed unless an employer files a VFCP application, the instructions to the Form 5500 don’t specifically require you to do so. Rather, per those instructions, a late deposit error will be fully corrected upon the “payment of the late contributions and reimbursement of the plan for lost earnings or profits.” Correcting outside of the VFCP, but following VFCP correction principles, should meet that requirement, allowing late participant contributions to be removed from your Form 5500.
Correcting late deposits of participant contributions can be time-consuming and potentially expensive - even if the lost earnings or excise taxes involved aren’t large, the administrative cost of correcting can be. Periodically reviewing your payroll deposit history will help you determine how quickly you’re able to deposit participant contributions in your 401(k) plan’s trust or custodial account. You should then examine your payroll procedures and processes to determine whether there are any pinch points that might prevent the timely deposit of participant contributions, and develop work around for those issues. Given the importance of ensuring the timely deposit of participant contributions, this is one case where an ounce of prevention is worth a pound (maybe even 2 or 3) of cure!
1 Since your 401(k) plan document likely describes when participant contributions should be deposited, late participant contributions are generally an operational failure, too.
2 A detailed discussion of prohibited transactions (as described under ERISA and the Internal Revenue Code) is beyond the scope of this article. The important thing to know here is that both the IRS and the Department of Labor treat late participant deposits as a prohibited loan from the plan to the employer during the period in which the participant contributions remain under the employer’s control.
3 An employer can only participate in the VFCP if neither it nor the relevant plan is “under investigation” – that is, under audit or investigation by the DOL, IRS, the PBGC, or other state or federal governmental agencies.
4 Additional information about the VFCP can be found here.
5 While the no-action letter will limit the DOL’s future actions with respect to a late contribution error, it won’t prevent other government agencies (like the IRS) from bringing action (to the extent they have jurisdiction).
6 Note, though, that there’s no “de minimis” exception for lost earnings. So, even if the amount of lost earnings is very small, it must still be paid to the affected participant’s account.
7 If you sponsor a 403(b) plan, the rules on late deposits of employee contributions, and the requirements for correcting such errors, generally apply to your plan, too. The excise tax, however, does not – 403(b) plans aren’t included in the definition of “plans” subject to the excise taxes imposed by Internal Revenue Code §4975. Congratulations – you can skip this step!
8 You may be able to avoid paying an excise tax of $100 or less under certain circumstances. Among other requirements, qualifying for this exception requires you to file a VFCP application and to either notify affected participants of the error or catching and correcting the error quickly.