Operational Failure. Corrective contributions. Voluntary correction programs. Excess deferral distributions. These all sound like strong, negative terms that an employee benefit plan would want to avoid. Yet, while they seem complicated, they can potentially be avoided if procedures are put into place to ensure the definition of plan compensation is being followed as set forth in the plan sponsor's plan document or adoption agreement (in the case of a pre-approved plan).
Using the improper compensation amount in the calculation and subsequent withholding of participant deferrals and in the employer match or discretionary deferrals is a common plan error. This can lead to a lot of work at extra costs to ensure the errors are corrected properly. Plan compensation should be clearly defined in the plan document or adoption agreement. There can be different compensation definitions for the different types of calculations as well. For example, employee deferrals may include bonuses as eligible compensation while employer discretionary contributions may exclude them from the definition.
Improperly including or excluding bonuses or fringe benefits as plan compensation is a common error we see as plan auditors. If the plan sponsor wants the eligible compensation to be a certain way, it needs to be reflected in the plan document. For example, if you want bonuses to be excluded from eligible compensation, the compensation definition needs to state that.
Errors often occur in this area and when the plan sponsors use a third party administrator to process payroll and benefits. The third party is not always made aware of the plan compensation definition or amendments to the plan document are not properly communicated to the third party. Sometimes the payroll systems are not updated to reflect amendments.
It is important that plan sponsors work with their third party administrators of their plans to ensure the definition is set up how the sponsors want it to be designed. Plan sponsors should also communicate with their payroll processors or external payroll providers to ensure that all deferrals are calculated in accordance with the definition. Amendments are permissible in setting up the plan how you want it.
If errors do occur, the plan sponsor will have to do corrections using Internal Revenue Service (IRS) correction programs. Distributions of elective deferrals will need to occur if the employee deferred on too much compensation, and the excess employer deferrals will need to be forfeited back to the plan and used in accordance with the criteria set forth in the plan document. In cases where the deferral was not high enough based on excluding some eligible compensation, the plan sponsor is usually obligated to make up 50% of what would have been the participants' deferral, 100% of what the employer match or discretionary contributions were in addition to earnings through the correction date. If any of these corrective measures are required, please be sure to consult with your third party administrator or your auditor to ensure the IRS requirements are followed properly in correcting these issues and to avoid potential penalties.
Procedures should be put into place to monitor these items. Assign someone to do internal checks on the deferrals and test payrolls that have unique situations (such as bonus pay or reimbursements) to ensure the calculations are proper. After all, a little work up front making sure the plan is set up properly and testing calculations timely will be a lot easier than making the required corrections.
