One of the Employee Benefits Security Administration’s (EBSA) primary objectives is protecting 401(k) plan participants. Title I of the Employee Retirement Income Security Act of 1974 (ERISA) addresses fiduciary responsibilities, of which the Department of Labor (DOL) oversees through the EBSA. As 401(k) plans became more popular and covered a vast majority of retirement plan participants, there was concern that there could be abuses in the timing between the deferral deductions from an employee’s paycheck and the date those deferrals were deposited to the plan. The EBSA began emphasizing enforcement of the timeliness of deposits in 1995; and, in 2010, enforcement became an ongoing National Policy Priority of the EBSA.

Why Are Late Employee Contributions Such a Priority?

The primary reason for the enforcement of timely deposits of employee contributions is the potential lost earnings to the employee’s account that, over time, can have a significant effect on retirement security. While in many cases the delay is simply the result of an administrative oversight or operational flaw, there is also the potential that the employer could benefit from such delays by having use of the money from the payroll date until the funds leave the employer’s general assets. The longer the delay, the longer the employer could potentially take advantage of the “float”.

Technically, once the funds are deducted from the employee’s paycheck, they are considered plan assets. If the employer has use of the funds, the employer would be using plan assets. The use of plan assets is considered a loan or extension of credit between the plan and the employer. Because the employer is a plan fiduciary, that loan is a prohibited transaction and a breach of fiduciary duty.

Note: “Employee contributions” includes employee deferrals (pre-tax and Roth), voluntary employee contributions (after-tax contributions) and employee loan repayments, to either a 401(k) or 403(b) plan.

Is There a Grace Period for Submitting the Employee Contributions to the Plan?

In 2010, the DOL issued a final regulation to assist small employers with a safe harbor period that would ensure compliance with the timely deposit of employee contributions. The regulation specifically provided a safe harbor of 7-business days for employers with fewer than 100 participants as of the first day of the plan year.

Now, that does not mean that small employers should delay in remitting the employee contributions to the plan. In fact, small employers are still bound by the “earliest date on which such contributions can reasonably be segregated from the employer’s general assets.” The regulation simply provides deemed compliance with the deadline, if a deposit does not exceed the 7-business day window.

Unfortunately, the DOL did not include a safe harbor applicable to plans with over 100 participants as of the beginning of the plan year. Large plans are held to the standard “earliest date on which such contributions can reasonably be segregated from the employer’s general assets” requirement with no automatically deemed compliance timeframe.

However, the DOL did provide an example applicable to large plans in Regulation §2510.3-102(f)(2) which demonstrates that participant contributions become plan assets as early as the 3rd business day following the date the paychecks are issued. While not explicitly stated in the regulations, that 4-day window has become the industry standard for determining whether a deposit to a large 401(k)/403(b) plan fails to comply with the “earliest date” requirements.

For large plans, this “earliest date” requirement is based on facts and circumstances in connection with regular payroll processing. If the employer establishes a pattern of segregating the employee contributions from its general assets in 3-business days, then 3-business days may be the “earliest date” for that employer.

For either size plan, the regulations include an outside limit of the 15th business day of the month following the month in which such amounts would have been paid to the employee in cash; HOWEVER, the DOL fully expects that the time needed to segregate the funds from the employer’s general assets should be substantially less than this outside limit. It should be noted here that the outside limit is mentioned solely because it is included in the regulations and cannot be relied upon in demonstrating that deposits were timely remitted.

Best Practices: Remit the employee contributions to the plan on the same day as the paychecks are issued. If the employer’s payroll department cannot deposit plan deferrals the same day as payroll because of administrative or system limitations, then employee contributions should be submitted within the three-business day industry standard in most cases.

How Do You Correct Deposits That Are Outside the DOL’s Timeframe?

Similar to the IRS’ Employee Plans Compliance Resolution System which is available to correct operational failures that may impact the plan’s tax qualified status, the DOL maintains a separate correction program specific to fiduciary breaches which encourages voluntary correction when there is a violation of the law.

The Voluntary Fiduciary Correction Program (VFCP) provides fiduciaries with relief from DOL enforcement action and from certain excise taxes paid to the IRS. VFCP may be used to request relief for remitting employee contributions to the plan beyond the DOL’s deadline and other prohibited transactions involving plan assets.

If you detect that employee contributions have not been transferred to the plan, the first step is to make sure that those funds are transmitted to the plan as soon as possible.

Note: If the employer historically makes employee contribution deposits within 1-2 days of the payroll date, the DOL may determine that all the employer’s deposits should have been made within the same timeframe. In other words, the employer’s past practices can establish the earliest date on which such contributions can reasonably be segregated from the employer’s general assets.

The Employee Contribution Deposit Was Late, Now What?

Even in this age of electronic fund transfers and file sharing, mistakes happen. Often, it is not the employer’s fault. Payroll providers and service providers may cause a late deposit to occur, but the DOL holds the plan’s fiduciaries responsible for overseeing third parties to which the fiduciaries have delegated responsibility.

The employer should notify the plan’s service providers if they discover a deposit which may be outside the DOL’s timeframe. Below is a general overview of the steps required to correct late remittances of employee contributions:

Determine which deposits were not timely remitted to the plan

Determine the lost earnings due to the plan

Allocate the lost earnings to the affected participant accounts

Pay the excise tax to the IRS (Form 5330) *

Report the late deposits on Form 5500 (must be reported each year until fully corrected)

Determine if a submission to the DOL will be made under VFCP *

*While it is common for employers to “self-correct” late deposits without a submission to the DOL, there are several benefits to filing with the DOL under VFCP. This includes the ability to utilize the online DOL calculator to determine the lost earnings amount and the ability of the fiduciary to request a waiver of the excise taxes due the IRS on the prohibited transaction (avoiding the need to file Form 5330 in certain cases), as well as a formal VFCP “No Action Letter” from the DOL clearing the employer of the potential breach of fiduciary duty under ERISA §502 (up to 20% of the amount recovered). If self-correcting, the lost earnings are determined using the actual rate of return and the 15% excise taxes must be paid to the IRS via the Form 5330. Furthermore, unlike the IRS-approved SCP approaches under EPCRS for plan qualification issues, the DOL doesn’t explicitly approve of any self-correction process under VFCP. Ultimately, it is up to the plan sponsor and the plan fiduciaries whether they wish to file under VFCP or wait to see if they receive an invitation from the DOL to participate in the correction program.

We Corrected the Late Deposits But Received an “Invitation” to File Under VFCP. Why?

Even if a plan sponsor self-corrects late deposits, there is a chance that the DOL will send an “invitation” for that plan sponsor to participate in the Voluntary Fiduciary Correction Program. As noted above, late deposits must be reported on Form 5500 for the year of the late deposit(s) through the year of full correction. A “yes” response to the delinquent remittances question on the Form 5500 (Schedule I or Schedule H, Line 4a; or 5500-SF, Line 10a), as well as the required supplemental “Schedule of Delinquent Participant Contributions” increases the likelihood that the plan sponsor will receive the invitation.

Unlike the IRS, the DOL does not recognize self-correction for fiduciary breaches, and the only assurance the fiduciary will receive is if the DOL issues a no action letter after completing the formal VFCP process. The DOL does not have any way of knowing if the late deferrals were corrected by the plan sponsor, unless the plan sponsor voluntarily filed under VFCP before the Form 5500 was filed.

The invitations are sent to plan sponsors who indicate there were late employee contributions, regardless of whether the Form 5500 indicates they were corrected. There seems to be some correlation between the amount reported as late and the total amount of employee contributions reported in the financial information. A higher percentage of total employee contributions reported as late will likely increase the odds of that plan sponsor receiving the invitation to participate in the DOL’s program.

Once the plan sponsor receives “the invitation” from the DOL, voluntary compliance becomes more critical. Or, as I like to think, a dinner invitation that you just cannot refuse!

Therefore, it is vitally important that plan fiduciaries act upon receipt of the DOL’s invitation; and it is highly recommended that steps be taken to apply under VFCP as soon as possible. If a plan sponsor does not submit the late deferral corrections under VFCP after receipt of the invitation, the chances of a full DOL investigation increase significantly.

The good news - there is no fee paid to the DOL for filing an application under VFCP. The bad news – you may incur some legal or preparation fees for compiling and submitting the application. The application includes physical documentation and proof that the deposits were made to the plan, that the lost earnings were deposited to the plan, and that any excise taxes were paid to the IRS. In addition, the plan fiduciaries must explain how the breach occurred and what steps and procedures the fiduciaries have implemented so that the breach does not re-occur.

What Happens After We File Under VFCP?

Once you have filed under VFCP, the application will be reviewed and the DOL may reach out to ask additional questions. In some instances, they may ask the fiduciary to provide proof that recent deposits have been timely remitted to the plan.

After the review is complete, the DOL will issue a “no action” letter regarding the violation of the use of plan assets. The “no action” letter means that the DOL will not take any civil action against the fiduciary (the applicant) and will not recommend legal action against the applicant and will not impose a civil penalty against the fiduciary.

Best Practices: If you choose to self-correct late deposits – make sure that you keep detailed documentation to support the correction, including the calculation of the lost earnings, the allocation to the affected participants, signed Form 5330 and copies of the cancelled checks/bank statements for the excise tax payments, payroll deposits and lost earnings.

Conclusion

If you discover that a late remittance of employee contributions has occurred, let your service providers know and begin the correction process as soon as possible. If you need guidance for fiduciary errors, you can rely on our experienced team to help navigate the available solutions. Our retirement service team at Newfront is available to assist you with any questions regarding employee contribution timing or other retirement plan related questions that may arise.

Email us at 401kHelp@newfront.com

Helpful Quick Links

DOL Voluntary Fiduciary Correction Program

IRS 401(k) Plan Fix-It Guide – You haven’t timely deposited employee elective deferrals

Definition of “Plan Assets” – Participant Contributions

DOL FAQs about Reporting Delinquent Participant Contributions on the Form 5500

DOL Fact Sheet on Employee Contributions

DOL Sample VFCP Invitation Letter

AICPA Timely Remittance of Employee Contributions in DC Plans

DOL Form 5500 Instructions