The vast majority of nonprofit organizations now have a defined contribution retirement plan in place. While some nonprofits have elected to move forward with the 401(k) plan model, many have chosen to offer a 403(b) plan. 403(b) plans have received more attention since 2009, when the written plan document requirement went into place. However, both 401(k) and 403(b) plans still do not receive the internal oversight and attention that they merit and require. At some organizations, the Human Resources department may be charged with plan oversight, while, for other nonprofits, perhaps the CFO or Controller is responsible for this task.
Some employees tasked with plan oversight may not realize that, depending on the degree and nature of their involvement with plan matters, they may be considered fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA). As such, they are subject to certain responsibilities, and with these fiduciary responsibilities comes potential liability. Fiduciaries who do not follow the basic standards of conduct may be personally and criminally liable for restoring any losses to the plan or for restoring any profits made through improper use of the plan’s assets.
Many plans fly under the radar because plans with fewer than 100 participants are not required to undergo an annual audit. Oftentimes, during the first year in which the plan is audited, the organization will begin shifting more attention to their organization’s retirement plan and looking more closely at the various associated compliance requirements. Plans with fewer than 100 participants might never go through this audit preparedness exercise; as such, they may be particularly vulnerable to plan compliance issues that have previously gone unnoticed.
This article is meant to help identify common compliance issues and other areas of concern that sponsors of 401(k) and 403(b) plans may uncover. The article is not meant to comprehensively cover all such issues or to identify the corrective methods should these issues be present. However, it is meant to spur further thought, internal discussion within the organization and external discussion with your trusted advisor.
One of the most common mistakes made by nonprofit organizations is delegating all retirement plan responsibilities to only one individual. Even the smallest of organizations needs to have internal controls in place to avoid assigning all plan-related matters to one individual. In many cases, an organization’s Board can assist with fiduciary oversight, coordination with plan management and, when necessary, the use of an external advisor. Best practice in this area is to form a retirement plan committee, comprised of members of management and the Board, which meets on a regular basis to monitor the performance of plan investments, reasonableness of fees charged by the plan’s record-keeper and/or trustee and to manage risk areas for the plan, ensuring that detailed minutes are kept for these meetings. If plan committee members do not have the expertise to perform these duties, the best practice is to engage an outside investment advisor to assist with this plan-monitoring process.
Another area that has received much attention from the Department of Labor (DOL) and Internal Revenue Service (IRS) is timeliness of contributions remitted to the plan’s record-keeper or trustee. As emphasized by the DOL, there is no grace period for plan sponsors to remit contributions. Regulation 29 CFR 2510.3-102 issued by the DOL states that an employer is required to remit amounts that a participant has withheld from his wages as soon as those contributions can reasonably be segregated from the employer’s general assets. In addition, ERISA Section 406 states that when an employer is delinquent in forwarding participant contributions and holds them commingled with its general assets, the employer will have engaged in a nonexempt prohibited transaction. This is required to be reported on both Form 5500 and the supplemental Schedule of Delinquent Participant Contributions, for which an excise tax must be paid. The DOL maintains that if payroll taxes can be submitted within one to two business days of the pay date, then employee deferrals can also be remitted within this same period. In order to avoid this issue, plan sponsors need to have a strong internal control system over employee deferrals, part of which is ensuring that there is a backup individual who is capable of remitting these funds should the primary individual responsible not be available for a certain pay date. A strong internal control system should include a review by another individual before the remittance is sent, as well as a review after the remittance is sent, to ensure that contributions shown as received on record-keeper and trustee reports agree with contributions on internal payroll reports.
A third common error is the mishandling of hardship distributions by the plan sponsor, if hardship distributions are permitted by the plan documents. One important factor to consider here, as well as in other areas, is that even though the plan sponsor may be relying on outside vendors for much of the plan administration, plan sponsors bear the ultimate responsibility for following the written plan, including hardship requirements. In fact, hardship withdrawals do come with a variety of requirements, many of which are dictated by the IRS. To start, a plan sponsor needs to go through a preliminary exercise before approving the hardship distribution in order to ensure that the hardship request meets plan and regulatory requirements. This exercise includes requesting documentation from the participant to substantiate an immediate and heavy financial need; in order to assist with this determination, the IRS has published a series of guidelines of certain distributions which the IRS deems to fall into this category. Additionally, the plan sponsor must verify that the employee has taken all other allowable options under the plan to attempt to remedy his or her financial need, including taking out the maximum allowable loan amount under the plan, if loans are permitted under the plan. Once these hurdles have been cleared and the hardship approved, a plan sponsor’s responsibility is still not complete. The plan sponsor must then prohibit the employee, under the terms of the plan or an otherwise legally enforceable agreement, from making employee contributions to the plan and all other plans maintained by the employer for at least six months after receipt of the hardship distribution. This could be even longer if dictated by the plan documents. Once this period of time is over, the plan sponsor is then responsible for ensuring the employee has the opportunity to reinstate contributions. As can be seen, hardship distributions come with a multitude of compliance requirements, which require timely attention by the plan sponsor, whether or not an outside vendor is used to assist with these determinations.
Stepping aside for a moment from specific areas of noncompliance, let us shift our attention to the plan documents as a whole. As previously noted, plan sponsors bear ultimate responsibility for following the written plan in all instances. Before getting to this responsibility, one common failure for smaller retirement plans without a strong relationship with their record-keeper is failure to adopt certain required plan amendments. Some plan sponsors go years and years without ever amending their plans, while in the interim, a myriad of plan changes may have been required, leaving their plan documents out of date and out of compliance before the actual operations of the plan are even considered. The IRS annually publishes a list of required plan amendments, which plan sponsors are encouraged to visit and discuss with their record-keepers to ensure the plan documents remain in compliance. Now, assuming that the plan documents are up to date, the burden then shifts to ensuring the operations of the plan match the requirements of the plan documents. One area that often receives special attention is the definition of plan compensation. Plan sponsors must ensure that those employees who are actually managing the plan’s operations, along with the payroll department, are all aware of how the plan documents define compensation for purposes of employee deferrals and employer contributions (if permitted), as well as any exclusions from plan compensation defined by the plan documents. Failure to understand these terms is bound to lead to an improper inclusion or exclusion of certain compensation for purposes of employees making elective deferrals or receiving employer contributions. Along with the definition of compensation, plan sponsors need to read and understand the plan’s provisions regarding eligibility, contributions, distributions, vesting and forfeiture provisions and other key areas. Once these terms are read and understood, they need to be communicated to all employees who have any role in the plan’s internal control system. Once communicated, plan management needs to ensure that plan terms are monitored for compliance internally on an ongoing basis, particularly if plan personnel change.
This article will have accomplished its purpose if it has prompted you to take a fresh look at the oversight process over your organization’s retirement plan. If you find yourself as the sole individual responsible for your organization’s plan, hopefully this article has prompted ideas about other parties to include as part of the oversight process. The areas discussed above are just a few of the common pitfalls for 403(b) and 401(k) plans; the good news is that for each of these pitfalls, solutions and remedies exist that can help bring the plan into compliance. Addressing these pitfalls now, in a proactive matter, will give you the peace of mind that, should the IRS or DOL ever come knocking on your door, you will be two steps ahead of them and have a model plan to present.