COVID-19 And Late Remittances of Employee Deferrals to 401(k) Plans
Many employers facing economic challenges because of COVID-19 have considered several possibilities for reducing their contributions to their 401(k) plans. Whether freezing safe harbor matching or nonelective contributions or deciding against making discretionary matching and/or profit-sharing contributions, the goal has been the same: reduce their employee benefits costs.
What many employers have not focused on doing, however, is ensuring that employee contributions (elective deferrals and loan repayments) to their 401(k) plans (“Employee Contributions”) continue to be deposited into the plans in a timely manner. The United States Department of Labor (the “DOL”) requires that an employer remit Employee Contributions to a 401(k) plan “on the earliest date on which such amounts can reasonably be segregated from the employer’s general assets, but in no event later than the 15th business day of the month following the month in which the amounts were paid to or withheld by the employer.” In the case of a “small” plan, i.e., a plan with fewer than 100 participants, the DOL has established a safe harbor under which the remittance of Employee Contributions is deemed timely if made within seven business days following the pay date. In the case of a “large” plan, i.e., a plan with at least 100 participants, the DOL generally will look at all deposits made for the plan year and, absent unusual circumstances, generally will take the position that the quickest remittance is what is required for all remittances. The 15-business day outer limit is reserved for circumstances truly beyond the control of the employer.
Recently, and in light of COVID-19, the DOL, in EBSA Disaster Relief Notice 2020-01 (the “Notice”), issued guidance intended to relax the timely remittance requirement for employers unable to satisfy the general rules described above: “The Department [DOL] recognizes that some employers and service providers may not be able to forward participant payments and withholdings to employee pension benefit plans within prescribed timeframes during the period beginning on March 1, 2020, and ending on the 60th day following the announced end of the National Emergency. In such instances, the Department will not – solely on the basis of a failure attributable to the COVID-19 outbreak – take enforcement action regarding a temporary delay in forwarding such payments or contributions to the plan. Employers and service providers must act reasonably, prudently, and in the interest of employees to comply as soon as administratively practicable under the circumstances.” (Emphasis added.)
The Notice requires that failing to remit Employee Contributions to the plan in a timely manner be “solely on the basis of a failure attributable to the COVID-19 outbreak.” Given this language, we recommend that an employer that cannot deposit or have its payroll provider deposit Elective Deferrals into the plan in a timely manner solely due to a COVID-19 issue document the existence thereof and how the Employee Contributions were deposited into the plan as soon as possible after the COVID-19 issue was resolved. Potential examples of COVID-19 failures that, in and of themselves, might cause untimely deposits under the general rules include furloughing the employer’s payroll staff or staffing shortages at the payroll provider.
Any employer sponsoring a 401(k) plan should care deeply about ensuring the timely remittance of Employee Contributions. First, an untimely remittance must be reported on the plan’s annual IRS Form 5500 filing. Depending on the amount reported, a DOL or Internal Revenue Service (“IRS”) audit of the plan could be triggered, as late remittances are higher audit risk items on the Form 5500.
Second, an untimely remittance of Employee Contributions is deemed to be an interest-free loan from plan participants to the employer sponsoring the plan. Such a deemed loan constitutes a prohibited transaction under both the Internal Revenue Code (the “Code”) and the federal pension law, the Employee Retirement Income Security Act of 1974 (“ERISA”). Penalties under the Code amount to 15% of the earnings that the late Employee Contributions would have generated each year, compounded annually; this penalty increases to 100% of the foregone earnings if the IRS discovers the untimely remittance before the employer remits the Employee Contributions and required earnings to the plan. The ERISA penalty would be 20% of the foregone interest.
Third, employees participating in the 401(k) plan tend not to look kindly upon untimely remittances of Employee Contributions (it’s their money!), especially if the employer is a “repeat offender.” Not only does this outlook increase audit risk, it creates employee relations issues that can be difficult to navigate.