Home / Archived Articles / IRS Identifies Top Compliance Problems for Small and Top-Heavy 401(k) Plans

Articles

IRS Identifies Top Compliance Problems for Small and Top-Heavy 401(k) Plans

Failing to secure bonding of plan fiduciaries and to amend plans in a timely manner ranked as the top error among small defined contribution/401(k) plans, while neglecting to test for top-heaviness, improperly excluding eligible employees and making incorrect allocations most plagued top-heavy 401(k) plans, according to data from the Internal Revenue Service.

Recent reports from the IRS LESE project—Learn, Educate, Self-Correct and Enforce—reviewed the most common problems uncovered upon examination of top-heavy 401(k) plans and defined contribution/401(k) plans with $100,000-$250,000 in plan assets. The project reports also include a discussion of how to avoid these errors.

Small Defined Contribution/401(k) Plans. According to the report, examination “revealed the expected” for these plans—issues brought about by less oversight and weaker internal controls. The most common problem involved inadequate bonding of plan fiduciaries and persons who handle plan funds, as required by ERISA Sec. 412. This provision calls for bonding of not less than 10% of the amount of funds handled, but in no case less than $1,000 or more than $500,000.

The other most common violation found in small plans was the failure to timely amend plans to comply with legislative changes or regulatory guidance. Such neglect can be very costly, as it can affect the qualified status of the plan.

Other compliance issues found among small defined contribution/401(k) plans included failing to timely file 1099-R forms; failing to allocate contributions and forfeitures per plan terms; joint and survivor waiver failures; impermissible distributions; failing to fully vest upon a complete discontinuance of contributions; and failing to include deemed distributions in income. Among the plans in this examination group that were 401(k) plans, ADP nondiscrimination testing failures and neglecting to timely deposit employee elective deferrals into trust also commonly occurred.

Top-Heavy 401(k) Plans. Examination of these plans—which provide more than 60% of the present value of benefits to key employees—found various issues, with about half of the plans having one or more compliance concerns. The top six compliance failures were:
 

• Securing adequate bonding.
• Satisfying the top-heavy requirements (including making the proper top-heavy minimum contribution for eligible non-key employees, testing for whether the plan is top-heavy, and including all eligible employees).
• Depositing elective deferrals into the plan in a timely manner.
• Recognizing and distributing excess contributions in a timely manner.
• Covering all eligible employees under Sec. 410 of the tax code.
• Properly providing the required safe harbor contributions in a designated safe harbor plan.

The IRS’s top tip for small plans and top-heavy plans to avoid compliance errors? Consult with your plan administrator or pension professional. This can, of course, avoid creation of compliance problems in the first place, as well as facilitate self-review to uncover problems before an IRS audit. The agency has a number of compliance resolution programs available that enable plan sponsors to be proactive in resolving inadvertent errors and to lessen the financial impact of correction. Additionally, the IRS publishes a booklet, the 401(k) Fix-It Guide, that addresses correction procedures for plan errors.