In a cash or deferred arrangement, elective deferrals represent employee wages which the employee has chosen to defer receiving until retirement by allowing the income to be deferred to retirement income. In so doing, the employee permits the employer to withhold this salary from wages and deposit it into the 401(k) plan on behalf of the employee. To safeguard the employee’s elective deferrals from employer delay and possible loss, the Department of Labor (DOL) has specific rules regarding the allowable timeframe for the deposit of these funds into the 401(k) plan’s trust. Once these elective deferrals are withheld from the employee’s pay, they are not to be considered available for use by the employer but must be deposited as soon as they can be segregated from the employer’s assets.
These Regulations are important due the abuse that has occurred due to some employer’s withholding elective deferrals and not depositing them into the 401(k). In some cases employer’s have even used the elective deferral funds for the employer’s benefit, for example, to defer the employer’s bankruptcy. Then, after the employer has gone bankrupt the elective deferrals are lost. Of course, the fact that this is fraudulent behavior does not stop some employer’s nor is it always easy to recover the employee’s elective deferrals. Thus, ERISA and the Department of Labor have clearly indicated that elective deferrals must be deposited as soon as they can be segregated from the employer’s assets.
Form 5500 Asks If Deposits Made in a Timely Manner
On the Form 5500, the DOL asks a question that addresses delinquent late deposits of elective deferrals. The exact wording of the question was as follows:
“Was there a failure to transmit to the plan any participant contributions within the time period described in 29 CFR 2510.3-102? (See instructions and DOL’s Voluntary Fiduciary Correction Program.)”
What is regulation 29CFR Sec. 2510.3-102?
This regulation requires an employer to deposit the elective deferrals:
- As of the earliest date on which such contributions (elective deferrals withheld from payroll) can reasonably be segregated from Employer assets, or
- In no event, later than the 15th business day of the month following the month in which the participant contribution amounts are received by the employer or the 15th business day of the month following the month in which such amounts would otherwise have been payable to the participant in cash (in the case the employer withheld the deferrals).
Although at first glance, it appears the employer has until the “15th business day” of the month following the month that the elective deferrals were withheld from the payroll, in reality the DOL treats this as the exception. The normal deadline for each employer is based on how quickly they make the deposit of elective deferrals on a regular basis. This is used as a benchmark for that employer. Thus, if an employer normally takes 5 business days to make the deposit of elective deferrals, that employer may not suddenly start waiting until the 15th of the month following the month deferrals were withheld.
In fact, some employers have found that if they have a special deadline, such as the end of the year and they make an extraordinary effort to deposit the elective deferrals in only, for example, two days, instead of the normal five days; these employers have been questioned by the DOL as to why they cannot make the deposit in two days all the time.
As of January 14, 2010 the DOL has set forth a general rule for small plans that do not require an audit of the Form 5500. For these plans deferrals and loan payments must be deposited to the plan no later than the 7th business day following payday.
Form 5500 Instructions Requires Independent Auditor to Review Deposit Timing
For large plans requiring an audit of the Form 5500, the DOL has added a requirement for the independent auditor to review that elective deferral deposits were made in a timely manner. This adds an extra layer of protection for the participants.
Electronic Movement of Funds Has Also Had an Impact
The DOL has also made it clear that the determination of what the earliest date the assets could be segregated is to be benchmarked based on other employer transmittals of payroll amounts. Therefore, to the extent that other payroll reductions, including taxes and insurance premiums, are being wire transferred to the appropriate parties within a day or two of posting payroll, this precedent would be used in establishing the earliest date the assets could be transferred with respect to the elective deferrals.
Handling A Late Deposit Situation
It is critical to adhere to these stringent deadlines as there are consequences for failing to comply. The plan sponsor, the employer, may be subject to penalties for late deposits. In addition, this is an area that the DOL is actively monitoring, and while an employer who answers the question with a “yes” is acknowledging that a prohibited transaction has occurred with respect to the plan, answering it “no” when there have been late deposits translates into filing a fraudulent return.
If the plan sponsor answers the question “yes” it is quite likely that the matter will be investigated further by the DOL including possibly triggering a plan audit. Late deposits are considered prohibited transactions and the employer must take steps to undo the prohibited transaction. Specifically, the employer must deposit the deferrals adjusted to reflect any earnings that would have been credited had the amounts been deposited in a timely manner. Lost earnings must be calculated using the DOL’s Voluntary Fiduciary Correction Program.
The employer will also need to complete and file a Form 5330 to calculate the 15% excise tax attributable to the usage of the money for the late deposit. This excise tax is determined based on the rate the employer would have paid to borrow the delinquent amount for the time in question. While this amount is generally quite small, it is important to take these steps in order to document the correction. Filing under the DOL Voluntary Fiduciary Correction Program will eliminate the prohibited transaction excise tax, however, since the excise tax amount is generally minimal, it probably makes sense to pay the excise tax as opposed to the VFCP filing fee.
Many employers do not file but self-correct in accordance with the VFCP program, If this is done, it is recommended that this be noted on the Form 5500, in order to let the DOL know that the correction has been done.
Because of the seriousness of the potential consequences, it is essential that plan sponsors understand that timely deposits are critical. In addition, adequate records are essential to prove that deposits have been made within the DOL guidelines.