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Sponsor News - August 2011

Failure to Withhold Elective Deferrals

Rev. 04/15/11; E-mail Alert 2011-6

A common error in plan administration occurs when an employee does not have the correct amount of deferrals withheld from pay because of their employer's misunderstanding of the retirement plan's definition of compensation. These errors typically involve compensation such as bonuses and commissions, which are paid in addition to an individual's regular rate of pay. This article will discuss the suggested IRS correction when an employer fails to withhold deferrals from an individual's bonus pay. The article will also cover how enhancements made to the "Bonus Option" section of McKay Hochman Co. Inc.'s nonstandardized Prototype Adoption Agreements for the EGTRRA restatement will reduce the likelihood of this error occurring in the future.

Example of Missed Deferrals on a Bonus

John elects to make an elective deferral of 10% of compensation for the 2009 plan year. The employer's plan does not exclude any type of compensation. The employer, however, mistakenly fails to withhold deferrals from John's annual bonus paycheck made on December 31, 2009. The plan also provides matching contributions equal to 100% of elective deferrals that do not exceed 6% of compensation. This error is discovered in 2011 during an audit of the 2009 plan year. What is the IRS's correction procedure?


The above facts are an example of an operational error caused by the employer's failure to follow the terms of the plan by not withholding elective deferrals from bonus pay. Appendix B of Rev. Proc. 2008-50, Employee Plans Compliance Resolution System (EPCRS), contains IRS's recommended procedure to correct a failure to withhold deferrals and the procedure for correcting the associated match.

Under EPCRS, the employer is to make a corrective contribution (called a Qualified Nonelective Contribution or QNEC) equal to John's missed deferral opportunity. The missed deferral opportunity is defined as being equal to 50% of an employee's missed deferral and must be contributed as a QNEC (adjusted for earnings). Appendix B 2.02(1)(a)(ii)(B)(2)

This QNEC amount represents what is called the "missed or lost opportunity" cost to the improperly excluded employee deferrals. It is based on an IRS analysis showing that an employee who received cash instead of making deferrals would lose a tax-free buildup equivalent to 50% of the deferral. Note that if matching contributions are also lost, the full amount of the lost deferrals will be used to calculate the matching contribution for the improperly excluded employee deferrals. The matching contribution is also to be a qualified contribution and may be made as a QNEC, rather than a QMAC. Appendix B 2.02(1)(a)(ii)(D)(2)

Missed Deferral Correction, With Associated Match

John's bonus: $10,000
Missed deferral: $1,000
Missed deferral opportunity (50% of missed deferral): $500, plus earnings
Missed Match formula 100% of deferrals up to 6%: $600, plus earnings
Under EPCRS, the employer is to contribute a QNEC in the amount of $1,100, plus earnings.

Rule Exception

The IRS provides a special rule under Appendix B 2.02(1)(a)(ii)(F) where an employer would not need to make a corrective contribution with respect to missed elective deferrals if:

  • The employee has at least nine months left in the plan year to make contributions, and
  • The employee is able to contribute the full amount that would have been withheld had the failure not occurred.

This exception does not apply to a missed matching contribution. If an employer makes an error that qualifies under this exception, then the employer will not have to contribute missed elective deferrals, but the employer must contribute a corrective QNEC for the missed match.


When fixing these types of errors, special attention must be paid to ensure that a corrective contribution does not cause the participant to exceed any applicable plan-specific or statutory limit.

The 401(k) auditor's wish list

By Kelly G. Parker, CPA
April 4, 2011

As we approach the audit deadline for employee benefit audit plans, hopefully things are already in motion with your plan auditors. You have received the list of items they need to complete the audit, documents have been exchanged, and meetings are planned.

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But what else can you do to make this year's audit more efficient, less painful and (dare we say) more enjoyable than last year?

As an employee benefit plan auditor with more than 18 years of experience working with hundreds of defined contribution plans, I have gone over my past interactions with plan sponsors and created a "wish list" for the things all auditors would like from their plan sponsor clients.

These wishes fall into three main categories: Be Prepared. Be Available. Be Proactive.

If you do these three things, you will be further on your way to meeting your audit deadlines, avoiding Department of Labor fees and penalties and keeping your audit fees in line with original estimates. Not to mention your auditors will be easier to work with and even more effective.

Be prepared
The largest part of preparation is being organized - check over your plan records well in advance of the first auditor communication you receive. I suggest starting after your year-end.
Your auditor should provide you with a document request list of the items they will need to perform the audit - start gathering those items immediately. An organized auditor will usually send out this list several months in advance - procrastinating could result in a scheduling delay, which means extensions, fees and possibly penalties from the DOL.

Keep copies of plan documents and amendments together in one folder - this will save a lot of time in the long run, and you'll avoid scrambling to find each amendment when asked by the auditor.
Send all requested information from the third-party administrator to your auditor in one package - don't send each piece one at a time as you have it ready. You will not only save your TPA's time, but your auditor's as well.

Keep plan/account transactions separate from regular accounting files, and maintain this information on a consistent basis.

Be available
Make yourself available to the auditors when they are working on your employee benefit plan audit, especially when they are onsite.

When possible, coordinate your schedules so you are in the office on the same days, even taking lunch at the same time so you can be available when the auditors need you. It may feel limiting for those few days, but think of it as managing your company's investment in the auditing process.

Provide your auditor with electronic access to your TPA's secure portal - then they can access the information easily and they won't have to take your time to get the information they need.

They know what they are looking for and can find it immediately, rather than going through a third party. Also, auditors will be viewing your financial data in depth - they can be trusted with this high-level access, or they shouldn't be your auditors.

When possible, respond to your auditor's requests within one business day. Audit teams are often organized to work on your 401(k) plan during a set time frame. Being responsive to their questions will keep them on schedule, which allows them to complete field work and have time for the partner review.
An uninterrupted timeline will result in full access to the firm's dedicated resources, quicker turnaround times, and fewer annoying follow-up emails from the auditors.

Be proactive
When you are asked to prepare a census to send to the TPA, send it to your auditors at the same time. You or the TPA will eventually have to send it to them anyway, so you are saving everyone a step.
When there is an issue to resolve, or a finding that the auditors need to report, work to fix it immediately.
At year-end, fix any errors to receivables/payables - are any monies owed to plan participants? Take care of those on your own before the auditor steps in almost half a year later to work on the audit.
If you have a question, just ask. It is better to get the matter resolved now, before you are staring down the approaching audit deadlines.

This year, I encourage you to at least grant one of these wishes for your 401(k) auditors - it will make their day and will most likely improve the entire process.

So Many Types of 401(k)s. Which is the Perfect Match for Your Business?

Apr. 26 2011 - 8:17 am | 663 views | 0 recommendations | 1 comment

When small business owners decide to start a retirement plan, they're often surprised by how many different types there are to choose from and can have trouble discerning which one's right for their particular business.

For those ready to add a 401(k) plan to their business, knowing the general ins and outs of each type of 401(k) can alleviate uncertainty and make selecting the plan that's right for your business much, much simpler.

When you get down to it, there are three core plan types to consider: a Safe Harbor 401(k), a Traditional 401(k), and a Tiered Profit Sharing 401(k). Here's the scoop on each:

  • The Safe Harbor 401(k)

The Safe Harbor 401(k) is the popular choice for businesses with less than 15 employees and for good reason. These plans allow business owners to contribute the maximum deferral amount to their own account ($16,500 in 2011 or $22,000 for those 50 year of age and over) and, at the same time, automatically satisfy IRS non-discrimination testing - a governmental check and balance that ensures plans serve all employees and not just a few at the top.

The business must provide a relatively small "safe harbor" match or contribution - an amount the employer puts into an employee's 401(k) account as a percent of an employee's compensation - so that any employee, including the owner, can contribute the maximum to the plan and receive the match too. The employer contribution is what helps the business automatically pass the government discrimination testing. It's also what gives owners and highly-compensated employees the ability to maximize tax-deferred contributions without the restrictions which can frequently be an issue for those going with a traditional plan (learn about traditional plans in the next section).

It's important to note that the government deadline for starting a Safe Harbor 401(k) for 2011 is October 1, but most providers have internal deadlines a couple of weeks earlier to allow for the time needed to set them up. And if you are looking to get the most savings and tax protection out of your plan this year, the earlier you start the better.

  • The Traditional 401(k)

A traditional 401(k) plan enables small business owners to customize their plan. This typically comes down to how the business prefers to reward employees. The company may not be in the position to offer a match at all. Or the business may have highly seasonal income so offering a regular matching contribution would not be a good option. Some businesses experience high employee turnover and prefer to use a multi-year vesting schedule for employer matching contributions to encourage loyalty and better manage contribution monies. And then some are better off only providing an employer contribution if the business hits its goals. These firms typically reward employees annually with a profit share.

The rule of thumb is that traditional plans are a good fit for businesses that are highly seasonal, or for those whose employees are expected to contribute seven percent or more of their salaries. In a traditional 401(k) plan, employers and highly-compensated employees (those making $110K or more in 2011) can contribute two percent more of their salary than the average percent of salary contributed by non-highly-compensated employees. So if the average employee in the business contributes seven percent of their salary, the owner will be restricted to contribute no more than nine percent of his salary, which often meets the owner's needs too.

  • The 411 on Matching in a Traditional 401(k)

It is important to note that matching is not required with a traditional plan. But when an owner does decide to provide a match, he can choose at what percentage of his employees' salaries and if he wants to use a vesting schedule. With vesting schedules, the business owner chooses a period of time that a percentage of the employer contributions will officially become the employees. For example, an owner could elect to match three percent of contributions made by eligible employees but it will vest over, say, a three year period. The owner might also allow for 50 percent of the amount the company contributed to become the employees in year one, 25 percent in year two and the remaining 25 percent in year three. After three full years, 100 percent of matches are fully vested in this scenario. Know that unvested amounts are returned to the plan to use for future matching contributions. This is quite different from Safe Harbor 401(k)s. With a Safe Harbor plan, a three to four percent match is typically required and employer matching contributions are vested immediately - meaning it is the employee's money once it hits their account.

  • The Tiered Profit Sharing 401(k)

And last, but certainly not least, we come to the preferred plan design for businesses with strong profits and fewer than fifty employees. Sometimes called an Advanced Profit Sharing 401(k) Plan, a Tiered Profit Sharing 401(k) as the name suggests rewards employees based on unique employee groups within a company.

For example, a legal firm has partners who bring in and own the business, front-line attorneys who work on each case, as well as support staff that handle administrative aspects of the firm's business. Each group is distinct, has differing compensation levels and is essential to the firm's success. A different percent of salary can be provided as a profit share for each defined group to reward employees based on the group's role and performance.

It can be great for the employees and a savvy way for the firm to better manage the cost of sharing profits too. It is common for these plan types to also provide a safe-harbor employer contribution to pass government tests.

So there you have the three most common 401(k) plan types. They offer great flexibility in aligning the plan with what you are looking to achieve with your business.

What other questions does this raise as you consider your options?