Late deposits—not worth the wait

In our first article regarding correction of 401(k) plans, we briefly mentioned the difference between corrections overseen by the Internal Revenue Service (IRS) and others by the Department of Labor (DOL). Below we will discuss how both of those agencies are involved in correcting late deposits.

401(k) Plan sponsors who withhold for participant contributions and/or plan loan payments (collectively referred to as “Participant Contributions”) must deposit such withholdings in a timely manner. Failure to do so is considered a prohibited transaction that is a fiduciary violation. Such violation may cause the plan sponsor to be subject to civil penalties and excise taxes.

When are Participant Contributions deposited timely?

The Department of Labor (DOL) has provided guidance in determining if Participant Contributions are made timely. The DOL guidance provides that a plan sponsor must forward Participant Contributions to the plan’s trust by the earlier of:

• The 15th business day of the month following the month in which the contribution is withheld by the employer from the employee’s wages, or
• The earliest date the Participant Contributions can reasonably be segregated from the sponsor’s general assets.

The 15th business day of the following month limit is not a date that will typically apply. The DOL has interpreted that such date can’t be used unless it can be successfully proven that the earliest date that Participant Contributions can be reasonably segregated is beyond such date.

The DOL has not given a definitive time frame used to determine the earliest reasonable date participant contributions can be segregated from an employer’s general assets. It is determined based on the plan sponsor’s deposit history and any other mitigating factors. For plan sponsors with efficient payroll processes, the earliest reasonable date could possibly be within a couple of days after a payroll date. Our experience is that the DOL typically will find that the remittance date for Participant Contributions to the plan’s trust should be within 3-4 days after the payroll date.

There is a more lenient time frame for plans with less than 100 participants at the beginning of a plan year. Remittance to the plan’s trust within 7 days are considered submitted timely. If a plan sponsor does not deposit Participant Contributions by 7 days under this exception, the earlier DOL deadline will be used to make corrections.

Plan sponsors should also consult the plan document for language that may require an earlier deposit date than the deadlines mentioned above.

Participant Contributions were not deposited timely. What should I do?

If you discover late deposits of Participant Contributions, transfer the funds into the plan’s trust along with lost earnings as quickly as possible after the error has been detected. Lost earnings are calculated from the earliest date it is determined the Participant Contributions could have been deposited into It should be the plan’s trust to the date they are deposited. If the deposit dates for Participant Contributions and lost earnings differ, earnings on the lost earnings will also need to be included. There is no de minimis amount exception for lost earnings.

The Form 5500 requires a response to the existence of any late deposits at the end of the plan year. A plan sponsor must report late deposits of Participant Contributions on the plan’s Form 5500 until they’re completely corrected. A good practice is to complete the correction before the annual Form 5500 is filed for the associated late deposits to reduce the plan’s risk for audit.

What are my options to correct late deposits?

The DOL provides a correction program for late deposits of Participant Contributions. It is called the Voluntary Fiduciary Correction Program (VFCP). An employer can only participate in the VFCP if they or the plan are under audit or investigation by the DOL, IRS, PBGC, or other state or federal governmental agencies.

Participation in VFCP requires the filing of an application with the DOL after late Participant Contributions and associated lost earnings are deposited to the plan’s trust. The application requires an explanation of the circumstances of the late deposit and corrections made. The DOL provides an online calculator to assist in the calculation of lost earnings provided a VFCP correction is pursued. There is no filing fee for a VFCP application but it does take considerable time to produce the documentation needed for the VFCP filing. Plan sponsors should anticipate several months to pass before a resolution to the VFCP application is received. The DOL will not institute a civil investigation of the late deposit error or impose civil penalties if a plan sponsor corrects under VFCP. Correction under VFCP does not prevent the IRS from bringing action. However, the IRS will typically defer to the correction made under VFCP.

It should be noted that, Plan sponsors are not required to correct late deposits of Participant Contributions through VFCP. Plan sponsors may self-correct instead. Self-correction would require depositing Participant Contributions along with associated earnings as mentioned above. The DOL VFCP online calculator, the protection against a civil investigation, and protection against civil penalties are not available under self-correction. The best practice is to use the greater of the plan’s rate of return or the IRS Code Section 6621 underpayment rate. Form 5330 will also need to be filed to submit excise tax penalties to the IRS. Plan sponsors need to weigh the administrative costs of filing for VFCP versus the risks of civil investigation and penalties to determine if self-correction is the course they wish to take.

What penalties apply for Late Deposits?

The civil penalty for late deposit of Participant Contributions is equal to 20% of the amount recovered as part of a settlement or litigation, if applicable, if correction is not made under VFCP. The excise tax on late deposits of Participant Contributions is 15% of the lost earnings associated with the late deposits. Late deposits that aren’t fully corrected before the end of a tax year are treated as late deposits for the next tax year, and will also be subject to the 15% excise tax for that year. The rules on late deposits of employee contributions, and the requirements for correcting such errors, generally apply to 403(b) plans, too. Excise tax is paid by submitting Form 5330 to the IRS. Like the calculation of lost earnings, there’s no de minimis amount of excise tax for which you can forgo paying the tax and filing a Form 5330.

VFCP allows for a waiver of excise taxes on delinquent deposits in certain circumstances. Those circumstances are (i) the delinquent deposits were made not more than 180 calendar days after the payroll withholding date, (ii) the plan sponsor has not taken advantage of VFCP and its related excise tax relief during the three (3) year period prior to the VFCP submission, and (iii) notice is provided to “interested parties” (and the appropriate regional office of the DOL’s Employee Benefits Security Administration) within sixty (60) calendar days following the date of the VFCP submission. There is an exception to the notice requirement if the amount of the excise tax that would otherwise apply is less than $100.

Summary

Plan sponsors should ensure that participant contributions and loan payments are deposited on a timely basis to avoid audit risk and cost of correction. Monitoring your payroll procedures will help prevent late deposits. Documentation of your payroll process will be a great resource to ensure proper monitoring and support in government audits. Milliman has a team of professionals who can assist with addressing late deposit questions and corrections, to please reach out to your Milliman service team or a Milliman compliance consultant for more information.