Money Management Executive
Retirement plan sponsors will be looking to their service providers for help in navigating the rules and regulations of the Internal Revenue Service and the Department of Labor.
And those providers better have answers, government officials and industry observers say.
"It is incumbent upon the service provider to know the law and communicate it to their clients and to assist them," said Mary W. Rosen, associate regional director for Boston at the Employee Benefits Security Administration, a division of the Department of Labor.
Wayne R. Kamenitz, executive director of the performance and reward practice at Ernst & Young, said any plan "only operates as well as its weakest link." If one of those links compromises the strength of the plan's chain of operations, there could be liability not only for the sponsor, but also for its service providers, he said.
"It's important to identify these problems before the IRS finds them," Mr. Kamenitz said.
He and Ms. Rosen made their comments during a panel presentation at the National Investment Company Service Association's recent East Coast regional meeting.
Betty McClernan, the acting director of employer plan examinations at the IRS, was another panelist at the meeting. IRS examiners target "pockets of noncompliance," she said "If you find problems in key areas, you're likely to find problems elsewhere."
Agents are required to expand exams as broadly as necessary, she said.
To avoid ugly encounters with the IRS and the Department of Labor, Mr. Kamenitz recommended that service providers and plan sponsors adopt a risk-based approach that mirrors the ones those agencies use. He enumerated common plan pitfalls for sponsors and service providers to consider.
For example, companies that reduce their staff must be aware of vesting and distribution, Mr. Kamenitz said. Vested employees must be treated as such according to plan documents, and all disbursements must be timely, he said.
Another common problem occurs during mergers and acquisitions. An acquirer's plan sponsors and their service providers must be careful to ensure that employees' records accurately reflect their starting date and that new employees are enrolled immediately in profit sharing or other retirement-related benefits, he said.
If the terms of an acquisition call for the seller's retirement plan to be dissolved, distributions must be done properly and swiftly, Mr. Kamenitz said, and people who are added to the staff as a result of an acquisition must be made aware of the terms of their new retirement plan and how prior service will be counted, if at all.
Plan documents are another major concern, he said; they must be issued promptly and circulated appropriately to employees. The IRS and the Department of Labor also typically check whether all plan amendments are delineated in the documentation, Mr. Kamenitz said.
Plan sponsors and their service providers also should double-check deferral percentages, he said; if they are calculated by a third party, without employer intervention, plans runs a higher risk of incorrect calculations.
Service providers must make sure also that the data they are provided is correct, he said.
The definition of compensation causes problems in 50% to 60% of all 401(k) exams, Mr. Kamenitz said. "It's easy to look at a plan and not see the definition of compensation."
For example, if an employee exercises stock options, the profits should be reflected in the employee's W-2 form as a type of income, he said, and those profits should be included when calculating the employee's plan deferral.
Likewise, incorrectly calculated compensation can cause employers to inadvertently exceed the IRS-set compensation ceilings, thereby allowing employees to participate illegally, he said.
According to Ms. Rosen, the Department of Labor is especially interested in ensuring deferred amounts and employer matches are applied to employees' accounts "as soon as reasonably segregable." Since 1998 the department has brought 159 indictments won $380 million of restitution for people whose employers held on to their portion too long, she said.
Bob Regan, the vice president of defined contribution services at Boston Financial Data Services Inc., said more often than not, the source of the problem is a misunderstanding of the rules defining "reasonably segregable," rather than malfeasance.
The rule states that the remittance must be made no later than 15 days after paychecks are issued. "That is not a safe harbor," he said; a payment that can be made earlier must be, or employers and their service providers could face penalties.
Sponsors and service providers also must ensure that all vesting calculations are accurate, and that any "break-in-service" rules are reflected accurately, Mr. Regan said.
Other frequent foibles involve plan loans, he said; securing spousal consent, preparing proper documentation, and suspending deferrals during the loan period are the types of details that slip through the cracks too often. Also, the borrower's distributions often are not properly reported on a 1099 form and are not subjected to the required excise taxes, he said.
Plans also face problems because their assets are not well enough diversified, they bear unduly large administrative costs, or their assets are lumped together as "other assets" on the balance sheet, Mr. Regan said.
In cases where an employer offers more than one type of deferred compensation plan, sponsors and service providers must examine the sum of all savings an employee might have, he said; otherwise, employees might be allowed to exceed the deferral limits prescribed by law.
According to Mr. Kamenitz, the best way to prevent the IRS or the Department of Labor from uncovering issues is to conduct regular compliance reviews, or to hire a third-party company to help. Fees for such reviews can often be charged to the plan assets, he said.
If such a review uncovers problems, Mr. Kamenitz said, he encourages his clients to enroll in one of the voluntary compliance programs offered by the Department of Labor or the IRS.
The IRS offers a program through which companies alert the agency of a problem with one of their plans and provide a strategy for correcting it. Once the problem is rectified, the plan sponsor must submit documentation of the steps taken and guarantees that such problems will not recur. During that time the IRS is precluded from opening its own investigation.
Federal agents dismissed questions about whether drawing attention to a plan's problems subjects the sponsor or service provider to increased scrutiny by agencies.
"It would be counter-productive" to do that, Ms. McClernan said. "We don't want to muddy the water."
