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Late Deposit of Participant Contributions

Many sponsors of 401(k) plans and 403(b) plans (and certain contributory welfare plans) will identify with the frustration of having to correct even minuscule amounts of late deposits of participant contributions to comply with applicable legal requirements, regardless of the fact that the costs associated with calculating those corrections may be highly disproportionate to the amount of lost earnings involved. Recent reports about new trends in the Department of Labor’s (“DOL”) enforcement activity in certain areas of the country highlight the challenges involved.

The DOL takes a strict view with respect to enforcement of untimely deposits of amounts withheld from employees’ payroll to the plan for a couple of reasons. First, delinquent contributions give rise to indirect prohibited loan transactions. (See: What is a Prohibited Transaction Under ERISA). Second, the DOL views late deposits as a warning sign that internal controls may be lacking (See: Protect Your Retirement Plan with Internal Controls). Late deposits could also result in an operational failure to follow the terms of the plan (which can be a disqualifying defect (See: 401(k) Retirement Plan Disqualification)if the governing plan document prohibits prohibited transactions. If there is a qualification defect, it may need to be corrected under the Internal Revenue Service’s Employee Plans Compliance Resolution System (“EPCRS”).

DOL regulations require that participant contributions and loan repayments become plan assets –and must be deposited in the plan –on the earliest date on which the contributions or repayments can reasonably be segregated from the employer’s general assets. While no “black and white” definition has been provided in the regulations for what a reasonable timeline is, factors to consider include processing time for payroll tax withholding, the internal systems in place, and any unusual circumstances (e.g., internet or electricity service outages, natural disasters, etc.). In practice, we have seen the DOL take an enforcement position that large employers should be able to deposit employee contributions within 0-1 day (and no later than the same date other with holdings and payroll taxes are deposited).

The late transmittal of participant contributions can be corrected by executing all of the following applicable steps:

  • Deposit the late participant contributions to the plan as soon as possible.

  • Allocate lost earnings on the late deposits to participant accounts. Lost earnings are calculated based on the greater of the plan’s actual rate of return or the IRS §6621 underpayment rate.

  • Pay applicable initial excise tax under IRC §4975(a) at 15% of lost earnings for each year and file Form 5330. If not corrected before the IRS sends a notice of deficiency or assessment, the IRS may impose a second-tier tax equal to 100% of the amount involved under IRC §4975(b). This excise tax is not applicable to 403(b) plans because the Code’s prohibited transaction rules under IRC §4975 do not apply to 403(b) plans.

  • Report the prohibited transaction on Form 5500

The employer or other responsible fiduciary may also submit an application under the DOL’s Voluntary Fiduciary Correction Program (“VFCP”). Filing under the VFCP is not required, but it secures the following benefits:

  • The DOL will waive the civil penalty for fiduciary breaches, which is equal to 20% of the amount involved.

  • If the conditions of PTE 2002-51 are satisfied, the applicant will be eligible for relief from the 15% excise tax under IRC §4975 (in which case no Form 5330 is required).

  • The employer can use the DOL’s online calculator, which uses the IRS §6621 underpayment rate, to compute lost earnings.

  • The DOL will issue a “No Action” letter.

There is no fee to file under the VFCP, but plan sponsors are likely to incur expenses relating to assembling and filing the submission, which can be substantial. Technically, employers who do not file under VFCP may not use the online calculator if the plan’s actual rate of return is higher, and they are not eligible for waiver of the applicable excise tax or the DOL’s civil penalties.

In the past the DOL has sent informational letters encouraging the plan sponsor to file under VFCP when it has self-corrected the late deposits and reported those transactions on Form 5500. Recently, the DOL’s tone has sharpened on this issue. It has been reported that some plan sponsors who submitted a Form 5500 reporting a late contribution received a letter from certain offices of the DOL’s Employee Benefits Security Administration (“EBSA”) describing the benefits of a VFCP application, but the letter includes new warnings:

  • Self-corrections made without participation in the VFCP will not be acknowledged by the DOL.

  • The VFCP calculator is intended for VFCP applicants only.

  • If the employer does not take advantage of the opportunity to file under the VFCP, the DOL may consider “possible alternative enforcement measures,” in effect hinting that the DOL may open an investigation unless a VFCP application is filed promptly.

The American Retirement Association (“ARA”) has submitted a comment letter urging the DOL to maintain consistency with its published guidance,and to consider adding a self-correction component to VFCP. The ARA letter opines that “plan sponsors should not be threatened with the heavy hand of a government investigation simply because they choose not to use a voluntary government program.”

If you have questions about deposit requirements and/or available correction programs, contact one of our attorneys.

© Boutwell Fay LLP 2018, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of June 29, 2018.

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