Aiken & Aiken, LLC – Attorneys at Law

Sheila Aiken September 22nd, 2008

Both the Internal Revenue Service (IRS) and Department of Labor (DOL) require that employee contributions are remitted in a timely manner.  Current IRS regulations mandate that employee 401(k) contributions must be remitted to the employer sponsored plan as soon as they can be reasonably segregated from the plan sponsor assets.  The regulations specify that they must be made no later than 15th business day of the month following the month in which the amounts are withheld from wages or received by the employer.  Additionally, the IRS has proposed a safe harbor for small plans – those with less than 100 participants – that these plans can comply with currently.

While some may interpret the regulation as a safe harbor limit, in practice, the key words in the regulation are that the monies must be remitted “as soon as they can reasonably be segregated”.  This means that if the funds can be segregated within a shorter period than the outside limit – for example, within a few days of the date of payroll – the funds must be remitted by this shorter time.

If contributions are not remitted in a timely manner, the failure could be held to be a prohibited transaction, a fiduciary breach or both.  There are significant penalties for both of these violations and, if there is a breach of fiduciary duty, then the plan’s fiduciary could be held personally liable.  Prohibited transactions, which can include a delay in the deposit of employee deferrals, continue until corrected by the plan sponsor.

Both the IRS and DOL have self-correction programs which can be followed to correct many qualification and fiduciary violations, including violations associated with the late remittance of retirement contributions.  In order to correct an issue with timely remittance of employee contributions, the voluntary compliance programs generally require that the plan sponsor make the participant whole by depositing the outstanding contributions as well as any lost earnings/interest or restoration of profit applicable during the time the employer held the participants’ funds.

The DOL has an online calculator that can be used to assist with this process.  An employer enters the required information into the calculator, which then performs the interest calculations and provides the plan sponsor with the amount of interest and/or lost profit due based on the greater of the two options. The online calculator uses the Internal Revenue Code (IRC) 6621(a)(2) underpayment rate for calculating interest owed and the IRC 6621(c)(1) underpayment rate for calculating restoration of profits.  The IRC underpayment rate is the sum of the federal short-term rate plus 3 percentage points.  The federal short-term rate changes quarterly, so the interest percentage used under this method will probably change every quarter contributions are delayed.

The IRS has recently indicated that, although full restoration is generally required, reasonable estimates of restoration amounts may be used when it is not feasible to obtain actual investment results.  If it is either (1) possible to precisely calculate the actual investment results but the difference between the estimate and the actual is insignificant and the administrative cost to determine the actual investment results would significant exceed the probable difference; or (2) it is not possible to determine actual investment results, then the DOL’s online calculator rates will be accepted by the IRS as a reasonable interest estimate.

Timely remittance of employee 401(k) funds is a process of which every fiduciary should be aware.  Additionally, fiduciaries and employers who use the 15th business day of the month following pay dates as a safe harbor need to take a close look at how payroll deductions are transmitted to determine reasonable segregation dates for their particular circumstances and take action to deposit the deferrals into plans on a more timely basis.

Where there have been violations, employers should consult with benefits counsel to understand the steps that will need to be taken to analyze which self-correction program is right for their individual situation and to ensure that all necessary steps of the program are taken.  Please contact our office for more information.

• ERISA , Pension , Retirement
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Michele Aiken September 15th, 2008

Most employers who sponsor a qualified retirement plan are aware of the requirement that the plan must have a written plan document.  However, just having that document is not enough.  ERISA plan qualification rules also require that the plan be administered according to provisions contained in the governing plan document.  If the plan’s operational administration does not follow the plan document, then the plan is not in compliance and is subject to fines and sanctions, up to plan disqualification.

Unfortunately, just hoping that your retirement plan operations are working correctly is not enough.  In the ERISA retirement plan world, some of the biggest mistakes made by employers are operational errors rather than errors in the actual structure or documents of the plan.  Because not all operational mistakes are “bad” or harmful to employees, many employers do not feel there is an issue if they make an operational error, provided it is to the benefit of the employee.  However, even errors that result in favor of the employee cause a plan operation issue.

For example, a plan document provides that employees are eligible to participate only after 1 year of service, but the employer generously allows newly hired employees to participate immediately upon employment.  This generosity on the part of the employer, while beneficial rather than harmful to employees, is a failure to follow the terms of the plan and would constitute an operational failure that could create problems for the plan’s qualification if not corrected.

According to the IRS, some of the reasons employers give to explain why their plans are not operationally compliant include:

• Not knowing how to identify and fix any errors.
• Not wanting to have any unnecessary contact with the IRS.
• Assuming that the required annual financial audit identifies any errors that need to be addressed.
• Assuming that auditing the plan for operational compliance would be too expensive.

Employers should routinely self-audit their retirement plans for operational compliance.  This self-audit should be performed at least annually or more often if there are any significant change in demographics or if the employer is involved in a merger or acquisition.  Unfortunately, the annual financial audit performed by your CPA won’t necessarily catch all operational issues that might exist.

If operational mistakes are found, employers need to use the tools available to them to correct the errors quickly and with the minimum of expense.  The IRS recently released the “401(k) Fix-It Guide”, available on the IRS’ website, which provides employers with a list of the most common plan errors and advice on how to fix mistakes for 401(k) plans.

Additionally, one of the best tools available to employers in their quest to correct operational plan errors is the IRS’ Employee Plans Compliance Resolution System (EPCRS).  The EPCRS is a comprehensive system of correction programs offered by the IRS to employers who offer qualified retirement plans.  This program allows employers/plan sponsors to correct plan failures through three separate components:

• The Self-Correction Program (SCP),
• The Voluntary Correction Program (VCP), and
• The Audit Closing Agreement Program (Audit Cap).

The EPCRS was recently updated to assist employers in their voluntary compliance efforts.  The changes are effective as of September 2, 2008 and include:

• Standardized application forms,
• Reduced filing fee for some plan loan failures, and
• Expanded situations where waiver of income and excise taxes are allowed.

Everyone knows that mistakes happen.  Under ERISA, the trick is to identify and correct those mistakes quickly and cost-effectively.  Contrary to popular opinion, the IRS is more interested in ensuring plans are compliant than in “catching” employers doing something wrong.  Benefits counsel can assist your organization in self-auditing your plan to help identify any errors and working with you and any necessary governmental agency to resolve issues.  Please contact our office with any questions or for more information.

• Benefits , ERISA , Health Care , Pension , Retirement
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Michele Aiken July 17th, 2008

On April 5, 2007, the IRS released final regulations related to Section 415 of the Internal Revenue Code (Code).  The final regulations closely follow the proposed regulations that were issued in 2005, with some changes, including changes that were made by the Pension Protection Act of 2006 (PPA).

Section 415 was originally added to the Code by the Employee Retirement Income Security Act of 1974(ERISA), and the initial regulations were issued in 1981.  In general, Section 415 sets limits on annual contributions allowed to qualified defined contribution (DC) plans and annual benefits provided under qualified defined benefit (DB) plans.  Included in Section 415 is a definition for compensation (§415(c)(3)) that is also used in a number of other instances for qualified plans, such as determining highly compensated employees and nondiscriminatory compensation for testing purposes.  One of the most significant provisions of the Section 415 final regulations involves post-employment compensation or severance pay.

The proposed regulations generally did not allow post-employment compensation to be considered compensation under Section 415 with 2 exceptions: (i) if the payments would have been paid if employment had been continued (such as overtime or commissions); or (ii) if the payments were due to accrued bona fide leave (such as vacation or sick leave) that would have been available if employment had been continued.  These exceptions would only apply if the compensation was paid out no later than 2 ½ months after termination of employment. 

With regard to the post-employment compensation, the final regulations adopted the proposed regulations with one adjustment.  The final regulations extend the time period for severance compensation payout.  Instead of requiring payment within 2 ½ months after termination of employment, payment of post-employment compensation (as allowed by the exceptions) must be made by the later of 2 ½ months after severance or the end of the limitation year that includes the participant’s termination date.

In addition, the final rules addressed areas such as:

• Post-termination payments from non-qualified deferred compensation plans as compensation
• Compensation paid to permanently and totally disabled participants
• Calculation of average compensation under a qualified defined benefit plan
• Combined contribution limits for participants in both a qualified DB plan and a qualified DC plan
• Required modifications due to the PPA

With certain exceptions, the final regulations are applicable to limitation years beginning on or after July 1, 2007.  For most plans, this means that the final regulations took effect as of January 1, 2008.  Generally, plans are required to be amended to comply with the Section 415 final regulations.  The plan amendments must be made by the employer’s deadline for filing its income tax return (including extensions) for tax year 2008 (sometime in 2009).  With 2008 already half gone, employers are encouraged to contact their benefits counsel to have their plans reviewed and amended for Section 415 changes as soon as possible.  For further questions about Section 415 changes, please contact our attorneys.

• Benefits , ERISA , Pension , Retirement
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Sheila Aiken June 24th, 2008

On June 17, 2008, President Bush signed the Heroes Earnings Assistance and Relief Tax (HEART) Act.  This bill includes a number of changes that may impact certain employee benefits plans.  For more details on the Heart Act, see our blog posted on June 2, 2008.

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Sheila Aiken June 19th, 2008

In recent years, the news has been filled with stories of large companies terminating or freezing their DB (pension) plans.  IBM, Sears, Verizon, and United Airlines are just a few of the companies that recently either closed their DB plans to newly hired employees, froze the benefit accumulation for existing participants, or outright terminated the plan. 

The well-publicized problems that some companies have experienced with their pension plans gives the impression that DB plans are no longer viable alternatives as employer-sponsored retirement vehicles.  However, that is not necessarily true.  In the right circumstances, DB plans could be the best option for some companies. 

A DB plan is a qualified retirement plan that is structured to provide a predetermined benefit to plan participants, usually defined in the plan as a specific amount or as a percentage of annual compensation.  Employer contributions to a DB plan are determined annually by an actuary and are non-discretionary.  Generally, the limitation on the annual benefit under a DB plan is the lesser of $185,000 in 2008 or 100% of the participant’s average compensation (limited to $230,000 in 2008) for the three highest consecutive years.  In comparison, the annual limitation for defined contribution (DC) plan contributions for 2008 is $46,000.  DB plans offer the opportunity for small business owners to possibly double or triple the maximum DC contribution limit applicable to 401(k) and profit sharing plans.

DB plans are making a resurgence for certain companies.  DB plans can be wonderful retirement vehicles for small business owners looking to maximize retirement savings in a relatively short time period, while minimizing the company’s tax burden.  Companies that have a predictable earning stream over a long period of time, with significant profits in excess of the owner’s salaries, should look at DB plans when considering their retirement planning strategy.  For example, a physician’s office, a law firm, a small CPA firm, or an investment advisor partnership may find a DB plan to be the best option for them.

A word of caution – while DB plans have many advantages, some of which are detailed above, they are not for every company.  DB plans tend to be more administratively expensive and burdensome than other qualified retirement vehicles, and they have less flexibility when it comes to annual contributions.  However, these drawbacks can be more than offset by the increased annual contribution amounts allowed and the accompanying significant tax savings for the right company. 

Employers interested in establishing a DB plan should consult with professional advisors before making any decisions.  Each employer’s situation is unique and should be objectively reviewed to determine what the best course of action is based on the employer’s own circumstances.  Some of the factors that will need to be considered are:  the company’s employee demographics, the company’s short and long-term growth projections, and the company’s historical revenue stream.  These and other factors can significantly impact whether a DB plan is right for a business.

Please contact our office for more information about whether establishing a DB plan is right for your business.

• Benefits , ERISA , Pension , Retirement
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