401(k): Plan Error:  Plan Operations Not Consistent with Terms of the Plan Document

You sponsor a great 401(k) plan for your employees.  Your employees seem to be happy with it.  It’s been in place for many years and as far as you know there are no issues.  You have heard no complaints.  As the plan sponsor and/or employer, it is your responsibility to keep the plan in compliance with the tax laws.  However, there may be many employees, multiple vendors and several tax professionals all servicing your plan. Are you sharing communications effectively with all involved?  Does the right arm know what the left arm is doing?  Have there been changes or amendments over the life of your plan that have been appropriately documented and/or communicated to all levels of administration to ensure operations match what the existing plan document states?  If the plan operations are not consistent with the terms of your plan document, your plan may be out of compliance and could be at risk of losing its qualified status.

People are busy these days.  With the people involved in the administration of your plan juggling several balls all at one time, it’s not uncommon for plan changes to be made but not communicated or implemented properly.  You should always convey any changes made to your plan document or to your plan’s operations to everyone who provides service to your plan.

For example, if you amend your plan document to change the definition of compensation, you should communicate that change to everyone involved in determining deferral amounts withheld from employee pay, performing your plan’s nondiscrimination tests or allocating employer contributions. Also, if you decide to use a different definition of compensation in operation, make sure you amend the plan timely to reflect that change. These are just a couple of examples. Below are some common changes requiring due diligence to identify any potential mistakes:

• If you made changes to your plan document, inform everyone who services your plan of those changes and what the changes mean to your plan’s operation.
• If you amend your plan document, you should also amend your summary plan description.
• If you materially modify your plan, you must give a summary of the material modifications to plan participants within 210 days after the end of the plan year in which you adopted the modification.
• If you’ve changed the way you operate your plan, communicate those changes to everyone who provides service to your plan. You may need to reflect these changes to your plan document through a plan amendment.
• If you’ve changed the plan trustees, you need to convey those changes and you may need to update your plan document and summary plan description.
• Any changes in the ownership interests or business acquisitions may affect the nondiscrimination testing for the plan. Convey these changes to your plan service providers.

You can ensure these steps are followed going forward, but are you confident they have been followed up until now?  What if there is a discrepancy that you are not aware of?  How do you find them and what do you do now?

How to find the mistake:

You must be familiar with your plan document to be able to determine if you’ve operated the plan according to its terms. It should lay out exactly how your plan is to operate and is crucial to ensure tax-favored treatment of the plan and to prevent a breach of fiduciary duty under ERISA.

1. Be familiar with the plan document wording and how it affects the plan operation.
2. Conduct an independent review of your plan and its operations annually.
3. If you operate your plan using a summary, check the requirements and definitions on that sheet to make certain they correspond to the plan document.
4. Consider conducting a 401(k) plan check-up using the 401(k) plan checklist.

How to fix the mistake: 

If you find an error in the operation of your plan, correct it as soon as possible. Use a reasonable correction method that places affected participants in the same position they would have been in had the mistake not occurred.  The IRS correction program (Revenue Procedure 2013-12) provides correction principles you should use in determining an appropriate correction method.

The type of error that occurs and how quickly it is corrected will determine which IRS correction program is available.

1. Self-Correction Program – allows some recent or insignificant errors to be corrected without paying a fee or contacting the IRS
2. Voluntary Correction Program – requires a filing with the IRS and payment of a fee (generally based on the number of plan participants) to correct operational errors and plan document errors that aren’t eligible for self-correction
3. Audit Closing Agreement Program – applies when errors are discovered during an IRS audit of the plan, requiring corrective actions and sanctions to be negotiated with the IRS

How to avoid the mistake:

Develop internal controls that will help prevent operational errors from occurring.

• Be sure to apply the provisions of the plan correctly when making a determination of what contributions or benefits are provided to participants, such as
  • confirming that all eligible employees are being offered the opportunity to defer at the right time or that automatic enrollments and automatic deferral increases are happening at the right time, and
  • periodically confirming that service data and vesting information is applied correctly
• Develop a way to communicate changes timely and accurately to plan administrators and outside service providers, such as
  • outside plan consultant
  • actuary and/or third party administrator
  • record keeper
• Have a clear process for making distributions from the plan that:
  • includes the plan procedures for ensuring appropriate authorization, accuracy and timeliness, and
  • identifies a team responsible to oversee payments
• Establish protocols and an action plan to use when errors are identified including the appropriate actions to resolve the errors.
• Identify the plan trustees as well as the procedures for tracking cash contributions and receipts by the trust custodian.
• Clearly identify the custodian of trust assets including procedures for maintaining trust asset data, communication mechanisms for transferring trust asset data to the trustee, and the reconciliation process including how to deal with errors.

If the “How to Avoid a Mistake” steps are followed and an annual plan review is held, your likelihood of errors will be controlled.  Staying in compliance is always easier, less time consuming and less costly than having to correct issues after the fact.  Just as you follow a regular check-up schedule for your own personal health, following a regular plan checkup schedule for your 401(k) will ensure your plan stays healthy/compliant too.

Additional Resources:

401(k) Plan Fix-It Guide
401(k) Plan Overview
EPCRS Overview
401(k) Plan Fix-It Guide (pdf)
401(k) Plan Checklist
Additional Resources

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