In a recent report, the Department of Labor noted the significant deficiencies and findings of the audits it performed of 2011 employee benefit plans. There was a strong correlation, it noted, between the number of audits conducted by an auditing firm and the rate of deficiency. Their underlying theory – the more pension audits conducted by a firm, the less likely there are to be significant deficiencies. While this may be true to a certain extent, (since after all, the more familiar a firm is with the pension industry, the more likely it is to catch the errors of the plan), the real question to ask is, why are there deficiencies to begin with? Surely, it is not the auditing firm that is sponsoring the plan and carrying out its daily operations. Many of the errors noted by the Department of Labor could be significantly mitigated if the plan’s sponsor (the employer) is aware of its role with relation to the plan and what that role really entails.
In discussions with other auditors of employee benefit plans they agree that, often times, those that are responsible for ensuring the safety and growth of retirement funds are spectacularly complacent with the importance of their fiduciary role. As defined by the Internal Revenue Service “a fiduciary is a person who owes a duty of care and trust to another and must act primarily for the benefit of the other in a particular activity. For retirement plans, the law defines the actions that result in fiduciary duties and the extent of those duties.” These responsibilities include:
- Acting solely in the interest of the participants and their beneficiaries
- Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan
- Following the plan documents
- Diversifying plan investments
- Carrying out duties with care, skill, prudence, and diligence of a prudent person familiar with the matters
While there must be at least one legal fiduciary as named in the plan document, the employer will generally hire other individuals to handle the daily operations of the plan. Because fiduciary status is determined based upon the functions performed by a person, and how many of those services are plan-related, there can, often times, be more than one fiduciary. Examples of plan fiduciaries include:
- the trustee – defined by the IRS as the individual “who has the exclusive authority and discretion to manage and control the plan assets,”
- the plan’s investment advisors – those who offer investment advice with relation to plan assets for a fee, and
- the individuals involved in the management of the plan
These individuals must first understand the purpose of their role, as defined above. The plan document (also known as the adoption agreement and any subsequent amendments thereto) is the criteria of judgment. Understanding the plan document and adhering to its provisions will alleviate many unnecessary issues that would otherwise be noted upon investigation. Wherever silent, the fiduciaries must act with prudence. By including this within the definition of a fiduciary, the governing bodies have truly encompassed all justifiable plan activity under one element – PRUDENCE. How can you, as fiduciary, determine your prudence (or imprudence)? Acting with prudence does not necessarily mean that plan investments won’t ever fail. Rather, it is taking the necessary steps to stem the loss. Changing the investment platform is a way to do this. Regularly monitoring the plan and documenting this process is an extension of prudence. This evaluation does not only revolve around the investments themselves but branches out to include the custodian who holds the assets, the record-keeper who maintains the plan’s books, and the remainder of the service providers who, in some way or another, are connected to the plan (e.g. the third-party administrator, payroll provider, plan’s auditor). It might very well be prudent to hire someone with fiduciary expertise to aid in the plan’s administration, but be aware that, as the employer sponsoring the plan, responsibility can never be completely relinquished.
So what exactly are these deficiencies that the Department of Labor and plan auditors are finding?
1.) A lack of understanding of the terms of the Plan Document
The plan document, as defined above, outlines all guidelines and acceptable activities of the Plan. The document will outline eligibility requirements for participating in employee and employer contributions, vesting provisions, distribution and loan requests, payment of withdrawals, the definition of compensation, etc. It is usually the lack of understanding of the terms of the plan document that will lead a plan towards noncompliance.
2.) Definition of Compensation
The Plan document will outline what compensation base to use when calculating contributions. Using the incorrect base will either lead to excess or insufficient contributions. For example, the plan document might exclude certain wages from the definition of compensation such as leave payments or bonuses. It is not at the employer’s discretion to decide what to include and what to exclude from this calculation. If the employer has errantly strayed from the document’s definition, it is absolutely essential that the affected participants be made whole again, including any lost earnings through the present day. An error such as this, once uncovered, is usually one that spans several years. To remedy such an error can be extremely costly to the Plan sponsor.
3.) Eligibility in Employer Contributions
While the eligibility requirements for participating in the Plan rarely pose an issue of non-compliance, I have recently seen an increase in the sponsor not crediting eligible employees with his/her share of employer contributions. Again, this issue stems from management’s lack of familiarity with the plan document and a misunderstanding of what the eligibility requirements are. Is there a service or age requirement? Is this a recurring service requirement? While these questions may appear basic in nature, many participants are annually affected and deprived of retirement funds that are rightfully theirs.
4.) Hardship Distributions
There are certain IRS guidelines to remember when approving employee requests for hardship withdrawals. Per the IRS, a participant may request a hardship withdrawal “because of an immediate and heavy financial need” (these needs are detailed further by the IRS). It is the sponsor’s duty to verify that this financial need is valid prior to approving such requests. Additionally, employees receiving such distributions are required to stop deferrals for a six-month period thereafter. Again, it is not the custodian’s responsibility, as believed by many sponsors, to ensure that the terms of the plan document are observed. All requests related to the plan, inclusive of hardship withdrawals, should be reviewed and approved by the sponsor.
5.) Timeliness of Remittances
This issue is not a new one. What constitutes a late remittance of employee contributions? According to the Department, employee contributions should be remitted to the Plan when they can be reasonably segregated from general assets, but in no event can the deposit be later than the 15th business day of the following month. While there is a hard deadline, plan sponsors should not confuse this as being the deadline with which they will be judged. If it generally takes the sponsor three days to remit contributions to the plan, then three days may be determined to be the “reasonably segregated” date. It is not a valid excuse to say that contributions were later than usual because the employee in charge of cutting the checks was on leave. What can the sponsor do in such scenarios? Ensure that there is always someone else available to carry out plan-related functions. Better than that, automatic electronic payments will always ensure that contributions are remitted to the custodian a fixed number of days after the pay date. Failure to remit timely is considered a prohibited transaction that requires disclosure in the Plan’s financial statements and the IRS Form 5500.
6.) Plan Overview & Oversight
We’ve already touched upon this in our discussion of the fiduciary’s role earlier and the “prudence” factor. To document the plan review process, the sponsor may elect to create a pension committee to review all things plan-related such as investment performance, service provider performance, fees paid by the plan and the sponsor, employer contributions for the year, etc. A committee would help as a “catch-all,” meeting regularly, to discuss all aspects of the plan. While this is not a requirement, it is a best practice, one that can significantly aid the sponsor in the event the DOL knocks on its door.
While there are additional errors that can be found with relation to defined contribution pension plans, errors/ deficiencies listed above appear to be the most common. Such errors will lead to non-compliance with the plan document and may require disclosure on the annual IRS Form 5500 and accompanying financial statements. To avoid the hefty penalties that the DOL can impose, which can reach as high as a whopping $1,100 per day, sponsors can remedy plan errors under the DOL’s Voluntary Fiduciary Correction Program (VFCP). It is in the sponsor’s best interest to remedy such deficiencies upon finding rather than giving the DOL the chance to fall upon such errors. The DOL has disclosed that it plans to investigate even more pension plans in the coming year. Such investigations are timely, costly, and can span multiple plan years. A plan sponsor’s understanding of the fiduciary role can significantly reduce, if not eliminate, these common place pension errors and will increase participants’ confidence that their retirement funds, their future, is in adequate hands.
Kenneth R. Cerini, CPA, CFP, FABFA