More Employers Considering 401(k) Benefits as Dow hits 30k

One of the few bright spots of 2020 has been the stock market. Notwithstanding a world-wide pandemic, tens-of-millions of lost jobs, thousands of shuttered businesses, and a battered health care system, the U.S. stock market has continued to climb. The Dow Jones Industrial Average (Dow) recently topped 30,000 for the first time in history. The stock market’s resurgence during the past few quarters has been good news for 401(k) plans. It has been such a bright spot that many companies who never before offered plans are looking to add them to their benefit lineup, and companies with longstanding 401(k) plans are touting their existence and performance to current and prospective employees.

There is no doubt that employer-sponsored 401(k) plans are, on par, a great benefit for employees. However, for employers a 401(k) plan can be fraught with potential pitfalls. Such employer-sponsored plans are not simple to administer, typically involve detailed tax reporting obligations to the Internal Revenue Service (IRS), and heap onto the employer a whole set of fiduciary responsibilities to administer the plan in accordance with the Employment Retirement Income Security Act (ERISA). As even seasoned employers have discovered, administering a 401(k) plan correctly can be difficult and is not an obligation that inexperienced employers should tackle alone.

A. Fee Amounts and Investment Options Matter

One aspect of 401(k) plans that many employers find appealing is that it seems like a “plug and play” benefit option that they simply set up and forget about. After all, employees choose their investment funds, the amount to invest, and now most plans are automated to the point of providing participating employees with access to plan and account data with just a username and password.

However, this view of 401(k) plans is misleading. Employers not only have to set the plan up in compliance with ERISA, but the employer has a fiduciary obligation (usually as the plan trustee) to make sure broker fees and investment options are reasonable. And since fees and the relative profitability of any investment can change — employers are obligated to monitor them and to adjust those options, if necessary, for the benefit of their employees. Yet, this obligation is easily overlooked by even savvy employers and has in recent years formed the basis of large-scale litigation against a couple of well-known Professional Employer Organizations (PEO).

For example, Insperity (a large PEO) recently settled a class action involving its 401(k) plan that had been ongoing since 2015. In that case, a group of employees alleged that Reliance Trust Co., Insperity, Insperity Holdings and Insperity Retirement Services breached their fiduciary duties and committed prohibited transactions under ERISA by (1) selecting untested investment options that performed poorly and kept those investment options in the plan despite their poor performance, and (2) paying the plan’s recordkeeper (Insperity Retirement Services) excessive administrative fees. Fortunately, for Insperity they settled without any finding of wrongdoing. But their protracted five-year litigation serves as a stark reminder for employers to carefully monitor their plan fees and investment options given to employees.

In a different case filed in May 2020 in New Jersey federal district court, a financial services company (McCaffree Financial Corp.) has sued another large PEO’s 401(k) plan (ADP Total Source). According to court documents, ADP’s 401(k) represented more than $4.4 billion in assets among about 114,000 participants as of the end of 2018. The lawsuit alleges that the costs and fees associated with the plan were unreasonably high. Between 2014 and 2019, the ADP 401(k) plan costs ranged from 65 basis points to 78 basis points, not including the fees of the five largest collective investment trusts on the plan’s investment options. By comparison, the average total cost of a plan of more than $1 billion as of 2016 was 28 basis points, according to BrightScope and Investment Company Institute data cited in the lawsuit. While this particular case has not been resolved, it underscores the liability minefield that employers can face unless they monitor their 401(k) plan fees carefully.

C. Failing to Timely File Form 5500

By far the most common mistake that employers make is failing to file or filing late their Form 5500. The U.S. Department of Labor (DOL), Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation jointly developed the Form 5500 Series so employee benefit plans could utilize the Form 5500 to satisfy annual reporting requirements under Title I and Title IV of ERISA and under the Internal Revenue Code. Employers must file the Form 5500 electronically with the DOL no later than the last day of the 7th calendar month after the end of the plan year. Employers can request a filing extension if they do so within seven (7) months of the end of the plan year. Failing to timely file Form 5500 (or to request an extension) can result in penalties imposed by both the IRS and DOL. The IRS penalty for late filing of a 5500-series return is $25 per day, up to a maximum of $15,000. The DOL penalty for late filing can run up to $1,100 per day, with no maximum.

D. Consequences for Late Employer Contributions to the 401(k) Plan

Another common mistake by employers is that they fail to make (or are late in making) the matching employer or profit-sharing contributions required by their plan. Some employers contribute the matching dollars each payroll period at the same time as the employees’ salary deferrals are put into the plan. Other employers make the full matching contributions in one payment, usually after the end of the plan year but on or before their federal tax filing deadline. Whether they do it each pay period or in one lump sum, in order to take the appropriate tax deduction, employers must deposit matching contributions into the plan no later than the business’s federal income tax return due date for that year (which differs depending on if your company is set up as an “S-corp”, “C-corp”, LLC, etc.). If the business has an extension to file the tax return, they must make the contribution on or before the extended tax filing deadline. For employers that also make profit sharing contributions, those have the same deadline as matching contributions.

Failing to make the contribution or making it late can have varying consequences for employers. They can range from losing a tax deduction for the contributions, making participants whole for lost earnings or interest, to severe sanctions such as plan disqualification and IRS imposed civil penalties.

E. New Pitfall for 2021: The “Long Term, Part-time” Employee

Traditionally, employers have been able to exclude from 401(k) participation those employees that it hires on a part-time basis (typically those who worked less than 1000 hours per year). The rationale for the exclusion has always been that part-time employees are not typically eligible for other benefits (such as health insurance, FSA’s, paid leave, etc.), so excluding them from 401(k) participation made sense from an administrative perspective.

However, in December 2019 President Trump signed into law the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act. This law created a new category of employee who is eligible to participate in employer sponsored 401(k) plans — the “long term, part-time” employee. This new moniker applies to any employee who in each of the last three consecutive years (“long term”) worked at least 500 but less than 999 hours (“part-time”).

Starting in 2021, employer-sponsored 401(k) plans must evaluate this class of employee for eligibility, vesting, and company contribution purposes. However, “long term, part-time” employees are not required to be allowed participation in the 401(k) until 2024. However, plans are free to be more generous and allow this class of employee to enter the plan sooner.

In a bit of good news for employers, their plan can still impose the 1,000-hour rule to be eligible for company contributions. Also, collectively bargained plans are exempt from these new rules.

F. Let the Experts Handle 401(k) Plans

Setting up a 401(k) plan for your employees is a great benefit, and many employers offer it. However, it is not simple to administer and can expose unwitting employers to financial liability. Failure to follow the rules set out by ERISA, DOL, and the IRS may result in personal liability, tax penalties, or even plan disqualification (meaning the 401(k) plan could lose its tax deferred status). Errors by employers are typically caused by administrative misunderstanding or application of the plan rules. Yet, these common pitfalls are absolutely preventable.

C2 Essentials offers a 401(k) plan to its clients and takes on the responsibility of administering the plan for its clients so that many of these mistakes can be avoided. For over 25 years, C2 has provided expert level human resources services so our clients can remain focused on their core business. When it comes to 401(k) plans, getting help on the front end is far better trying to dig out of trouble on the back end.

C2 provides strategic HR outsourcing to clients who want to develop optimal workforce strategies and solutions to allow them to be more competitive and profitable. C2 blog posts are intended for educational and informational purposes only.

Originally published at https://www.c2essentials.com on December 4, 2020.