In order to protect employees’ savings, the Employee Retirement Income Security Act of 1974, as amended (ERISA) mandates that any person(s) responsible for managing or administering a retirement plan (the plan’s “fiduciaries” or “you”) act prudently. The Department of Labor (DOL) is tasked with periodically investigating ERISA-covered plans to ensure the fiduciaries are complying with applicable laws and regulations.

When it comes to administering your plan, both the DOL and the Internal Revenue Service (IRS) look to the required government filings, participant inquiries or complaints, and the voluntary compliance resolution system filings to identify if you’re meeting your fiduciary obligations.

Understanding what’s required in the administration of your plan, including required government filings, participant disclosures, and common administration failures, can help you avoid being the subject of a regulatory investigation.

OVERVIEW OF FIDUCIARY RESPONSIBILITIES

ERISA requires plan sponsors to act prudently when making decisions relating to the management or administration of the plan. The requirements imposed on fiduciaries help protect the assets of employees and provide some assurance to the regulators and plan participants that the plan is being managed properly through the receipt and review of required plan documents and disclosures.

Governing Plan Document

A retirement plan is initially set up through the adoption of either a custom or pre-approved (prototype) plan document which specifies eligibility requirements, the types of contributions permitted, and various optional features. Once adopted, companies must operate and administer their plan according to the terms of this legal document. As regulations change, this document must be amended, and the plan operations must reflect any updates.

Eligibility and Vesting Determinations

Those individuals at the company responsible for notifying employees of eligibility to participate in the plan must be familiar with the terms of the plan document in order to correctly calculate years of service and identify when to allow employees into the plan.

Participant Contributions, Distributions & Loans

In processing plan deferral instructions, plan sponsors must be able to demonstrate that employee contributions are remitted to the plan at the earliest date possible and within the guidelines outlined in ERISA. In addition, when processing loans or hardship requests or making plan distributions, you must use the specific terms in the plan document to ensure distributions are correctly administered.

Non-Discrimination Testing

To ensure the plan benefits rank-and-file employees and highly compensated employees equally, plans are required to conduct certain discrimination tests each year, and if necessary, take steps to equal out the benefit.

Participant Disclosure

In order to ensure participants have enough information about their plan to make informed choices about participating and investing in the plan, the law requires certain disclosures to be provided to participants. The type and timing of the required disclosures vary, but ultimately, the plan sponsor has the responsibility to ensure all reporting requirements have been met.

Required Government Filings

Finally, in order to be able to monitor compliance with the regulations that govern qualified retirement plans and to ensure the plan is operating according to the adopted plan document, there are additional disclosures that must be made to the government each year, and these disclosures are closely scrutinized for compliance.

All of the responsibilities discussed above are generally referred to as operational compliance or administration. While many aspects of plan administration are outsourced to a third-party administrator, the most common operational compliance failures happen at the company level due to a lack of awareness of either the regulations or the terms of the plan document. This Guide and your plan consultant will be able to assist you with the education you need to better understand your responsibilities with respect to operational compliance and administration as required under ERISA.

GOVERNING PLAN DOCUMENTS

When you establish a retirement plan for your employees, you must first adopt a written plan document which serves as the foundation for day-to-day plan operations. Depending on the needs of your company, you might adopt a pre-approved prototype plan document (that has already been reviewed and approved by the IRS) or hire an ERISA attorney to help you design a custom plan which carries additional costs to develop and maintain.

As new laws are enacted or existing laws amended, your plan document must also be amended to reflect the changing regulations. If you’ve adopted a pre-approved plan, the provider that supplied the document will provide support in meeting the changing regulations; however, and you’ll need to engage an ERISA attorney to amend your custom plan document. In either case, the responsibility for keeping your plan document current with the regulations and operating your plan according to the plan terms falls on you as the plan sponsor.

1. Ensure that employees with responsibility for operations and administration are familiar with the plan document provisions (HR, payroll, etc.).
2. Understand what changes are required to your plan document by checking the IRS Required Amendment List and follow-up with your service providers or ERISA attorney to verify the proper amendments have been filed.
3. Notify plan participants of any significant changes to the plan either through the distribution of a Summary of Material Modifications (SMM) or an updated Summary Plan Description (SPD), as required.
4. Monitor and verify that the plan is operating in accordance with the terms of the plan document.
5. Watch out for areas where the IRS often finds a failure to follow the terms of the plan document.
   a) Not properly identifying eligible employees to give them an opportunity to participate in the plan.
   b) Not applying the correct definition of compensation when determining the compensation eligible to be deferred or computing the matching contributions.
   c. Not following the terms for allowable loans and hardship withdrawals.
6. Keep in mind that any document adopted to assist with plan oversight becomes a plan document subject to scrutiny by regulatory authorities (such as an Investment Policy Statement, Education Policy, Committee Charter or Bylaws).
   
   

While setting up a plan is optional, following the terms of the plan once adopted is a requirement. For this reason, you should put a process in place to ensure those responsible for operations and administration are familiar with and follow the terms of the plan.

ELIGIBILITY AND VESTING DETERMINATIONS

ERISA sets minimum requirements for determining when an employee is eligible to participate in the plan and when he/she has a right to any contributions the company makes to match employee deferrals.

During the process of setting up your plan, you choose if you want to make your eligibility into the plan less restrictive than what the law requires. You can allow immediate vesting of employer contributions or select from one of two vesting schedules.

Generally, a plan may require an employee to be at least 21 years old and to have a year of service with the company before the employee can participate in a plan. However, plans may allow employees to begin participation before reaching age 21 or before completing one year of service.

It’s important that those responsible for notifying employees of their eligibility into the plan understand the terms of the plan in order to avoid inadvertently excluding eligible employees.

When a plan is set up to provide matching contributions, knowing how to properly calculate years of service and what vesting schedule to apply will affect your plan’s operational compliance.

Understanding eligibility, years of service, and vesting is an important requirement of the individuals at the company who have responsibility for notifying employees of their right to participate and for calculating vested balances upon termination. It’s essential to ensure they have the information necessary to apply the terms of the plan correctly.

PARTICIPANT CONTRIBUTIONS, DISTRIBUTIONS, AND LOANS

The DOL and the IRS pay special attention to how plan assets are handled, both coming into and going out of the plan. Failure to meet specific rules regarding the handling of plan assets can lead to disqualification of the plan which could result in taxation for the participants and loss of deductions and penalties for the employer.

Three areas where operations are examined closely by the IRS:

Participant Contribution

The law requires that participant contributions be deposited in the plan as soon as reasonably possible to segregate them from the company’s assets, but no later than the 15th business day of the month following the payday. The 15th day clause is often misinterpreted to mean that the plan has leeway, but in reality, if a plan can segregate and send the assets the day after they are withheld and fails to do so, they are in non-compliance with the law and subject to corrective action.

For plans with fewer than 100 participants, salary reduction contributions must be deposited with the plan no later than the 7th business day following withholding by the employer.

In the case of an audit or inquiry, the DOL will review the plan document to identify what is stipulated regarding the timing of contributions. They will review your ability to timely deposit employee deferrals and compare that to when you actually submit the assets to the trust to determine compliance.

Distributions

While the law allows for certain distributions due to death, disability and severance from service, employers may allow for additional options such as in-service withdrawals if defined in the plan document. It’s important that responsible parties understand what kind of distributions are allowed and how to calculate the vested balance based on service requirements when making those distributions.

Additionally, you will want to ensure that those individuals who reach the plan's age for required minimum distributions, either age 70 1/2 or age 72, are given proper notice, the required minimum distributions calculations are correct, and the proper tax reports have been sent.

Loans and Hardship Withdrawals

While plans are not required to include loans or hardship withdrawal features, many are set up to permit these types of distributions.

In offering loans, responsible parties will need to refer to and closely follow the plan provisions for making loans, including the loan amount, loan term and repayment terms.

For allowing hardship withdrawals, it’s important that you keep a record of all information used to determine whether a participant was eligible for a hardship distribution and the amount distributed was the amount necessary to alleviate the hardship.

Non-Discrimination Testing

Plan sponsors must test traditional 401(k) plans each year to ensure that the contributions made by and for rank-and-file employees (nonhighly compensated employees or NHCE) are proportional to contributions made for owners and managers (highly compensated employees or HCE). As the NHCEs save more for retirement, the rules allow HCEs to defer more.

Definitions

Highly compensated employee: An employee who earned more than $125,000 in 2019 ($130,000 in 2020) or owned more than 5 percent of the business. (The compensation limit is based on the previous year’s compensation while the ownership limit is based on the previous or current year.)

Nonhighly compensated employee: Everyone else.

ADP and ACP Tests:

The nondiscrimination tests for 401(k) plans are called the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. Many plan sponsors hire a third-party administrator (TPA) to perform these tests (often the same party contracted to do the plan’s recordkeeping).

ADP or Actual Deferral Percentage: Compares the average salary deferrals of HCEs to those of NHCEs. The deferral percentages of the HCEs and NHCEs are averaged to determine the ADP of each group. To pass the test, the ADP of the HCE group may not exceed the ADP for the NHCE group by 1.25 percent or the lesser of 2 percentage points and two times the NHCE ADP.

ACP or Actual Contribution Percentage: Is calculated the same way as ADP, but instead divides each participant’s matching and after-tax contributions by the participant’s compensation.

If your plan fails one or both of these tests, you must take the corrective action described in your plan document during the 12-month period following the close of the plan year for which the test failed. A plan failure of the ADP test typically can be corrected in one of two ways: (1) pay any excess contributions back to the HCEs or (2) pay a qualified non-elective contribution (QNEC) to the plan for all NHCEs. A plan failure of the ACP test typically is corrected by (1) distributing vested matching contributions or (2) forfeiting of any excess employer contributions by the HCEs.

In addition to the Non-Discrimination Testing, your plan may also be subject to additional tests such as Top-Heavy Testing.

Since 401(k) plans are designed to benefit all employees equally, it’s important to understand the restrictions placed on deferrals by HCEs and put a strategy in place to avoid failing the non-discrimination tests.

PARTICIPANT DISCLOSURES OVERVIEW

As the plan sponsor of a retirement plan, it’s your fiduciary responsibility to provide a variety of disclosure documents and notices to plan participants and their beneficiaries.

Plan disclosure documents keep participants informed about the basics of plan operation, alert them to changes in the plan’s structure and operations, and provide them a chance to make decisions and take timely action for their accounts.

While many of these disclosures are created and distributed with the assistance of your service providers, you retain the responsibility for ensuring the proper notices were, in fact, distributed to the eligible participants at the correct time. However, consider working with your plan consultant to better understand the role that your service providers play in developing and distributing the disclosures described below.

Identifying Who Should Receive Disclosures

Many of the disclosures not specific to a special distribution event must go to all eligible employees (whether participating or not), current participants and beneficiaries with account balances, as well as terminated participants and alternate payees with a balance.

Timing of Distributions

There are several notices that must be provided to employees and participants at various intervals. Below are some of the more common notices (not an exhaustive list):