The timely deposit of elective deferrals and loan payments concerning 401(k) plans continues to be a major emphasis of examinations conducted by the Department of Labor (DOL). These examinations were implemented to safeguard any contributions withheld from an employee’s pay for the intent of being directly transferred to their employee benefit plan. The DOL’s examinations ultimately put a focus on the general rule, not the maximum time period rule (which are both explained below).
The DOL regulations require amounts withheld from employee wages to be deposited:
As of the earliest date they can be segregated from the general assets of the employer (known as the general rule), but in no event later than the 15th business day of the month following the month in which the amounts were withheld (known as the maximum time period rule).
The Time Period Rule
The time period in which to comply with the general rule is based on the employer’s circumstances. The maximum time period rule is not a safe harbor that an employer can rely on when depositing 401(k) deferrals and loan payments. Fortunately, there is a safe harbor rule that applies to small plans (meaning those with less than 100 participants as of the beginning of the plan year). Small plans are permitted to deposit elective deferrals and loan payments within seven business days following a pay date.
Failure to Deposit
Late deposits of employee deferrals and loan payments must be reported on the annual Form 5500, and they must be reported every year until they are corrected. If there are amounts reported that have not been corrected, employers increase their chances of a DOL audit. In addition, failure to timely deposit employee deferrals and loan payments is deemed to be a loan from the plan to the employer, or rather, a breach of fiduciary duty and a prohibited transaction. Prohibited transactions are subject to a 15 percent excise tax payable to the Internal Revenue Service (IRS) on Form 5330.
It should be noted that there are two different methods for correcting the late deposits of elective deferrals and loan payments. These include:
The DOL Voluntary Fiduciary Compliance Program (VFCP) is a program that allows you to report late deposits to the DOL. In exchange for applying under VFCP, the DOL will issue a “no action” letter that states they will not recommend the plan for audit based on this issue.
Self-Correction is simply correcting the late deposits without going through VFCP. Self-correction involves less paperwork and can usually be handled much quicker.
Each method involves the calculation of lost earnings. Lost earnings are calculated from the date the deferrals should have been deposited to the date of actual deposit. Lost earnings are based on the greater of the investment return the participant would have earned had the deferrals been invested timely or the rate of interest equal to that charged by the IRS for underpayment of taxes. Since the earnings calculation is the greater of the above two amounts, it will always produce a positive return.
If you have any questions regarding the DOL’s deposit requirements, please call or email our office.