401(k) plans require much maintenance to meet fiduciary requirements. There are many mistakes that can creep in over time that put you out of compliance. Here’s a list of potholes that can wreck your plan with the IRS:

-         Not updating your plan to reflect current laws

-         Not operating the plan in accordance with the plan document

-         Incorrect definitions of compensation for deferrals and allocations

-         Lack of consistency with employer matching contributions

-         Failing the 401(k) ADP and ACP nondiscrimination tests

-         Excluding eligible employees

-         Not making timely deposits of employee elective deferrals

-         Incorrectly administering participant loans or hardship distributions

-         Not making required minimum contributions

-         Delaying filing the Form 5500-series return

-         Not distributing a Summary Annual Report to all plan participants

Instead of losing sleep over the problems that come with non-compliance, the IRS provides a simple to understand 401(k) plan fix-it guide. The guide includes how to find, fix and avoid mistakes. Regular review of this list and making note of your compliance actions can save you time and work when it’s time for an audit.

This year, when you make New Year’s resolutions, be sure to have one about checking on the fees you pay to administer your plan. Even a company like Walmart, with its extensive legal resources, recently agreed to pay $13.5 million dollars along with Merrill Lynch for a class action settlement. Without admitting any fiduciary wrongdoing, they agreed to eliminate funds from their plans that carried high fees. A few reminders:

1. Know what fees you pay and be prepared to justify them to your plan participants as well as the DOL.
2. Be sure that record-keeping fees are documented separately from investment management fees.
3. Diversify your plan portfolio, offering choices to plan participants.
4. Communicate all changes to your plan participants and employees – clearly and promptly to avoid any misunderstandings.

Your plan auditor is a good source of information about ways to keep your plan in top fiduciary shape. Another good resource is the AICPA’s Accounting and Auditing Resource Centers.

Once you make an amendment to your plan, how and when you communicate with plan participants is an important ERISA requirement. A case this fall, Helton v. ATT, Inc. (Sept. 16, 2011), points to four important lessons in communication:

1. Answer plan participant questions in a timely and concrete manner

Your communication with plan participants is best put in writing whenever possible. Documenting answers to questions that come from plan participants about their
specific situation keeps everyone on the same page.

2. Prepare and distribute a Summary of Material Modifications (SMM) or Summary Plan Description (SPD)

You technically have 210 days after the plan year in which the changes are adopted to communicate changes. However, you’re better off preparing and distributing
materials as soon as possible to make sure that those affected by the changes can act accordingly. And, the task is complete – it won’t be overlooked with the passing of time.

3. Keep records of how and to whom SMM or SPD notices were sent.

If it’s possible for plan participants to somehow miss a piece of communication about plan changes, you need documentation to prove that the proper notice was sent in the time required by ERISA. Documentation may be as simple as a mailing list of recipients.

4. Remember that all plan participants and surviving beneficiaries need a notice, not just current employees.

This communication tip may seem obvious, but unfortunately, it’s not always followed.

In an effort to save money, some companies are terminating their retirement plan options. However, as long as funds are still present in a plan, companies with more than 100 eligible participants remain required to have an annual audit even if the plan is terminated.

The key word is ‘eligible.’ If a plan is active, participants are considered eligible if they have an opportunity to participate, even if they do not elect to do so. If you terminate your plan due to reduction in force, you need to know how many participants (present and former employees and beneficiaries of deceased former employees receiving benefits) you have to determine if you still need an audit. A reduction in force that creates a 20% or greater drop in participants is called a ‘partial termination.’

One important consideration about full or partial termination of a plan is that the matching contributions and other employer contributions must be fully vested for all participants when a plan is terminated. This rule applies regardless of the vesting schedule. A participant’s elective deferrals in a 401(k) plan are always fully vested, but the employer portion is based on the plan document provisions.

Here are the criteria for a fully terminated plan:

-         An established date of termination

-         A description of the benefits and liabilities of the plan as of the termination date

-         Distribution of plan assets as soon as administratively feasible, typically within one year after the termination date

If a plan is a qualified plan, then participants will have tax-favored status for the distribution amount. Otherwise, participants are liable for taxes, or can designate a rollover account to defer taxes on the distribution amount.

How to prepare for a new definition of fiduciary

By now you have probably heard that the DOL will announce changes to the definition of ‘fiduciary’ in early 2012. The purpose is to strike a balance between protecting consumer accounts from biased investment advice and allowing the securities industry to have enough ability to add value without excess regulation. Briefly, the anticipated revisions:

1. Clarify that fiduciary advice is individualized advice directed to specific parties
2. Clarify fee issues that allow for broker commissions without undue burden on plan participants
3. Clarify the rules about conflict of interest when providing investment advice

Plan sponsors can prepare for the revised fiduciary definition by reviewing plan documents and making sure that the information is included that may need attention:

1. Does the plan document clearly state investment advice relationships?
2. Are fees that are currently part of the retirement plan structure clearly delineated?
3. Are participants given choices that negate opportunities for conflict of interest?

When the new definition is announced, you will want to communicate with plan participants. Detail any impact the definition has on the structure of your plan.

For complete information about the proposed new definition of ‘fiduciary,’ see the DOL Web site.

You work hard to be compliant with all your fiduciary duties, so make sure that you don’t get tripped up with definitions of compensation for plan contributions. Here are types of errors to avoid:

• Commissions – Contributions to plans may be on ‘auto-pilot,’ pulling from a base salary. Make sure that commissions are included if such are required by the plan document.
• Contribution rate   The rate of contribution used in payroll should match the rate authorized by the participant.
• Cost-of-living increases – Make sure thatcontributions don’t exceed the maximum deductible amount for each year.

Take action:

1. Define all possibilities for compensation and amount of employer contribution in your plan document. Be sure to include timing issues such as how to handle compensation that is earned prior to entering the plan and compensation that occurs upon termination. (Examples include vacation and sick pay.)
2. Review your plan periodically, spot checking specific employee situations. You’ll make sure that your established system is working properly, and compensation-related benefits are consistent with the terms of your plan.

Compensation errors are quite common. They’re also easily correctable. However, if you don’t correct the error yourself and have and IRS audit, your plan can receive a significant financial penalty.

Please talk with your financial advisor or plan auditor to make sure that your plan is on track. As with all things IRS, the details and exceptions are numerous.

It was discouraging to see the article in Forbes last week (August 16, 2011) titled, “Why 401(k) plans are doomed from the start.” From an auditor’s point of view, looking at hundreds of 401(k) plans, I think a better title would be, “The challenges facing 401(k) plans.” While responsibility lies in both courts, the participant and the sponsor, I will address a few of the issues that are put upon the sponsor to support my readers in optimal plan management.

1. Document the reasons for plan investment decisions. Financial brokers can bring you information that is helpful in making investment decisions. That doesn’t mean that you are relying on them as fiduciaries or that there is anything improper about the relationship. However, you need to protect yourself with having a range of resources and document all plan decisions.  Preferably, have a plan committee that includes non-biased fiduciaries.
2. Define your plan fiduciaries. Make sure that your plan document includes the credentials and relationships of all of the fiduciaries with input into your plan. See my previous post, Trustees vs. Fiduciaries, for more information.
3. Understand the relationship between plan costs and associated fees. As we have said before, much scrutiny is applied to plan fees by both disgruntled participants and the DOL. Be fully aware of the fees you pay and document committee decisions.
4. Keep your Investment Policy Statement up to date. The issues discussed above relate to your current Investment Policy Statement. Your Investment Policy Statement provides validation for the integrity of your decisions. It is also an important element to demonstrate compliance to ERISA and DOL rules and regulations.
5. Use your audit as a tool to improve your plan. Companies with 100 or more participants are required by law to have an annual audit. Your auditor can be a valuable resource for suggestions to improve operations and protect yourself from liability.

A common plan mistake that I see is plan sponsors not monitoring forfeiture accounts. Forfeiture accounts occur when monies are set aside to match employee contributions to retirement plans, but the employee terminates prior to fully vesting. The ‘forfeited’ money is supposed to be distributed within the terms of the plan. Generally, the balance held in the forfeiture account should be fully allocated at least once a year. Therefore, the balance of forfeiture accounts should be ‘zero’ at least sometime during the year. The IRS states those forfeitures may be used to:

-         Pay for a plan’s administrative expenses and/or

-         Reduce employer contributions

Here’s what you can to do make certain that your company is in compliance:

-         Put a provision in the plan document to detail the handling of forfeited monies.

-         Monitor forfeiture suspense accounts to be sure that monies are not carried into a subsequent plan year.

If you have already made the error, it’s possible to self-correct the mistake without penalty within a two-year period. See the Employee Plans Compliance Resolution System (EPCRS) for information about a Self-Correction Program and Voluntary Correction Program.

A recent Supreme Court decision is a stark reminder for plan sponsors
to double check the consistency of Summary Plan Documents with the current plan
document. In CIGNA Corp. vs. Amara, the Court held that companies can be
responsible for ‘equitable relief’ that occurred when CIGNA changed the plan
from a defined benefit pension plan to a cash balance plan. Regardless of the
circumstances, court decisions are weighing in on the side of the plan
participants in stating that detrimental reliance does not always need to be
established. Companies are exposed to ERISA class action suits, and individuals
are not responsible for citing specific harm.

What you can and need to do: Review your Summary Plan Documents (SPDs)
in light of your plan provisions. Seek the advice of an attorney if you think
you need to add provisions to the SPD or create a more detailed summary in your
plan provision statement. As a precaution, ask your auditor if he/she thinks
that you need additional details to protect your company and plan participants
from discrepancies in documentation.

Here are more questions from the IRS to ask yourself as you prepare your plan for an audit:

1)      Were employer matching contributions made to all appropriate employees under the terms of the plan?

Not as simple as it sounds, employers can unknowingly violate the terms of the plan with matching contributions.

• Check your plan for rules regarding deferred income.
• Properly identify plan entry dates and hours of service (if applicable).
• Be sure to calculate amounts on an annual instead of pay-period basis.
• Be aware of any changes made in the plan since the last audit to be sure to comply with the changes for all participating employees.

 2)      Has the plan satisfied the 401(k) nondiscrimination tests (ADP & ACP)?

ADP is Actual Deferral Percentage and ACP is Actual Contribution Percentage. Each year there must be a balance of the two (ADP and ACP). This has to do with the amount contributed by non-highly compensated employees (NHCEs) in relation to the amount contributed by highly compensated employees (HCEs). As the amount contributed by NHCEs grows, the amount that HCEs can defer increases. See the IRS document or talk with your auditor if you have questions in this area.

3)      Were all eligible employees identified and given the opportunity to make an elective deferral election?

It’s important for your plan to have a definition of eligible employees. Generally, this is all employees who receive a W-2.  You can reduce the risk of excluding employees from the election opportunity by keeping records of dates of birth, dates of hire, dates of termination, number of hours worked, compensation for the plan year, 401(k) election information and any other information necessary to properly administer the plan.

For more detail, visit http://www.irs.gov/pub/irs-tege/401k_mistakes.pdf.