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ERISA COMPLIANCE AND ERRORS
Top Ten Mistakes
Marcia S. Wagner, Esq.
Introduction

Plan sponsors and financial advisors need to know on
what to focus when they examine a plan. They need to
know the top ten errors, how they occur (usually people
do not know the terms of the plan’s administration) and
how they should be rectified. For each of the “top 10”
problems, we discuss: (i) the issue, (ii) how it arises
and (iii) how it can be fixed.
2
Top Ten Problems
1. Automatic Enrollment & Automatic Escalation
2. 403(b) Plan Universal Availability
3. Problem Shared and Leased Employees
4. Compensation Done Incorrectly
5. Controlled Group Issues
6. Bad Plan Documentation
7. Prohibited Transactions
A. Plan Services
B. Bad 408(b)(2) Disclosure
8. Illiquid Plan Assets
9. Late Elective Deferrals
10. Bad Administration
3
1. Automatic Enrollment &
Automatic Escalation
4
Automatic Enrollment & Automatic Escalation

Applies to any plan allowing elective salary deferrals

Employees enrolled in plan unless elect otherwise
◦ Plan document specifies percentage
◦ Employees can opt out or elect different percent
◦ Default percentage must be uniformly applied

Qualified Automatic Contribution Arrangement (QACA)
◦ Exemption from nondiscrimination testing conditioned on :
 Default deferral percentage:
 Starts at 3% and increases to 6%; maximum 10%
 Matching Contribution (100% match up to 1% of
compensation plus 50% between 1% and 6% of
compensation) or 3% Nonelective Contribution
 100% vesting in matching or nonelective contribution after 2
YOS
 No hardship distributions for required employer contributions
5
Automatic Enrollment & Automatic Escalation


Eligible Automatic Contribution Arrangement (EACA)
• Withdrawals allowed within 90 days of first auto contribution
Notice Requirements for QACA and EACA
• Written explanation of rights not to have auto contributions or to elect
deferral percentage other than default percentage
◦ Timing: reasonable period before beginning of each plan year
◦ Must give reasonable period of time after receipt to make alternative
election and, in the case of a QACA, to make investment elections

Excess Deferrals
◦ Participant must notify plan by April 15 of following year
◦ Corrective distributions of excess deferrals to be reported on Form
1099
◦ Potential double tax if excess not withdrawn by April 15
6
Automatic Enrollment & Automatic Escalation

Failure 1
• Plan sponsor fails to implement plan’s auto enrollment provisions by
not deferring salary of an employee who did not make an election
• Corrected by providing nonelective employer contribution. Missed
deferral is the plan’s auto enrollment deferral percentage multiplied by
employee’s compensation. Required corrective contribution under IRS
VCP is 50% of this missed deferral

Failure 2
•
Employee never receives enrollment materials and is, therefore
treated as an excluded participant rather than a participant whose
deemed election has not been implemented
•
Corrected by making nonelective employer contribution equal to
50% of missed deferral which is the ADP for the employee’s group
(NHCE or HCE) multiplied by employee’s annual compensation
7
2. 403(b) Plan Universal
Availability Problem
8
403(b) Plan Universal Availability Problem

Elective salary deferrals must be available to any employee
◦ Exceptions
 Employee who will contribute $200 or less annually
 Employee eligible to make elective deferrals to 457(b) or
401(k) plan or another 403(b) plan
 Nonresident aliens
 Students performing certain services and certain employees
not meeting minimum age and service requirements
 Employees normally working fewer than 20 hours per week
 Exception conditioned on working less than 1,000 hours in a
12-month period and subsequent 12-month periods
 No part-time exception
◦ Universal availability applies separately to each 501(c)(3) entity
even if multiple entities participate in same plan
9
403(b) Plan Universal Availability Problem


Universal availability standard met only if at least once
each plan year plan lets employee make or change a
cash or deferred election
◦ Universal availability requires meaningful notice of
right to defer
Rule only applies to elective deferrals, not employer
match or discretionary or mandatory employer
contributions
◦ Some plans are drafted so that the eligibility standard
for these nonelective contributions is the same as
universal availability. In these cases, operational
failure occurs if universal availability not applied to
nonelective contributions.
10
403(b) Plan Universal Availability Problem

Failure 1:
◦ Excluding employees based on a job classification which is not one of
the classes excepted from universal availability rule, such as part-time
workers
◦ Corrected by making employer contribution under IRS VCP program of
missed deferral Rev Proc 2013-12 provides special rule for calculating
403(b) corrective contribution which will generally be 1.5% of
employee’s compensation adjusted for lost earnings and any match.
Mistake may be eligible for self correction if error was insignificant and
sufficient compliance procedures were in place

Failure 2
◦ Failure to properly notify a group of employees of their right to make
deferrals
◦ Corrected by making employer contribution under same methodology
as Failure 1.
11
3. Shared and Leased
Employees
12
Shared and Leased Employees

Employee status controls application of plan rules
◦ Control (over when, where and how to perform services) is key to
determining whether worker is common law employee (1992 Supreme
Court Darden case, Rev Rul 87-41

Shared employee definition: a person working for ( and under
control of) more than one business at a time
◦ Example: staff nurse working for several medical practices
 Each practice is the employer simultaneously and credits all hours of
service for purposes of plan eligibility
 Pro rata share of shared employee’s compensation from each employer
is allocated to the separate plans maintained by each employer

Failure:
◦ Violation of qualified plan rules to exclude nurse from participation in any
retirement plans maintained by medical practices if nurse has 1,000 hours
of service overall
◦ Correction: require each plan to include nurse as participant
13
Shared and Leased Employees

Leased employee definition: a person on the payroll of one
company but working for another company
◦ Example: employee on payroll of PEO who actually performs services
for PEO’s client. If client controls the leased employee’s work, however,
employee will be treated as employed by client, not as a shared
employee (Rev. Proc. 2002-21)

For purposes of plan coverage, vesting, nondiscrimination and top
heavy rules, a “leased employee” is treated as an employee of
client organization, not PEO (Code §414(n))
◦ Definition of leased employee
 Full time – 1 year
 Contract between client organization and PEO for employee services
 “Primary” control by client organization
14
Shared and Leased Employees

Safe Harbor exception to treatment of leased employee as employee of
client if employee is covered by PEO plan, subject to:
◦ Leased employees no more than 20% of client’s NHCE workforce
◦ Money purchase plan
◦ Minimum contribution(nonintegrated) - 10% of compensation
◦ Full vesting
◦ Immediate participation by the leased employees

Failure
• IRS takes position that if leased employee is effectively a common law
employee of client, covering this employee under PEO plan violates
exclusive benefit rule
• Correction: Exclude employee from PEO plan. Also include leased
employees as participants in client plan unless client plan specifically
excludes them. If client maintains 401k) plan, inclusion of leased
employees may require making nonelective contributions that
compensate leased employee for missed deferral. Consider amending
plan to exclude leased employees
15
4. Compensation Done
Incorrectly
16
Compensation Done Incorrectly

Amount of plan benefits or contributions frequently expressed as percent
of compensation
◦ Code §401(a)(17) limits annual compensation that can be taken into
account
 Limit in 2014 will be $260,000

Plan definition of compensation must be nondiscriminatory under Code
§414(s)
◦ Designed based safe harbors
 Include regular or base salary or wages and commissions, tips, overtime,
premium pay and bonuses
 Exclude reimbursements, expense allowances, fringe benefits, moving
expenses and deferred compensation
◦ Reasonable formula not favoring HCEs
 Examples: Rate of pay vs. actual pay - Pay only while plan participant vs. pay
for entire plan year
 Plan that includes bonuses but excludes overtime might be treated as
discriminatory
 Test is whether average percentage of total compensation included under the
definition for HCEs exceeds by more than de minimis amount the average
17
percentage of total compensation included for NHCEs
Compensation Done Incorrectly

Failure 1: Plan allocation is based on compensation that exceeds
the limit
◦ Correction (two alternative methods)
 Reduce account balance of affected employee by improperly
allocated amount (adjusted for earnings); if excess amount would
have been allocated to other employees in year of failure, it must be
reallocated to those employees after adjusting it for earnings
 Alternative fix: adopt plan amendment increasing maximum
percentage of compensation and contribute additional amount for
each other employee who received an allocation in failure year
 Example: plan contribution rate equals 5% of compensation
 5% applied to Employee X’s $300K comp. In 2012 when limit was
$250,000 - reduce X’s account by $2,500 excess and reallocate
 Alternatively, retroactively amend plan to raise rate to 6%
18
Compensation Done Incorrectly

Failure 2: improper exclusion of bonuses, overtime, commissions
or another element of compensation from base on which
employees may make elective deferrals
◦ Correction: employer contribution equal to 50% of missed deferral
opportunity which would be the employee’s elected percentage of
compensation that would have been deferred from the excluded
compensation element. Also contribute any applicable match and lost
earnings

Failure 3: Improper deferral on items not included in plan
definition of compensation
◦ Correction: Distribute excess elective deferrals plus earnings to
participant. Forfeit match related to excess deferrals and either
reallocate or use to offset future employer contributions
19
5. Controlled Group Issues
20
Controlled Group Issues

Rules apply as if all controlled group employees worked for
employer adopting the plan
◦ Applies to eligibility, vesting, minimum participation, determining contributions
and benefits, nondiscrimination, compensation limits, top heavy rules and
simplified employee pension and simple retirement accounts

Minimum Participation Example
◦ Failure: Company A maintains a qualified plan with a one year service
requirement only for its employees but is a member of a controlled group of
corporations that includes Company B. Employee X completes 3 years of service
with Company B and then transfers to Company A.
◦ Correction: The plan must recognize X’s service with Company B and admit her
as a participant immediately.

Highly Compensated Employee Example
◦ Failure: Company C and Company D are controlled group members each of
which pay Employee Y a salary of $60,000 for 2013.
◦ Correction: For purposes of nondiscrimination testing, Employee Y will be
considered highly compensated, since the HCE limit for 2013 is $115,000 and
Employee Y’s aggregate compensation is $120,000.
21
Controlled Group Issues

Discrimination Testing Example
◦ Failure: Company E maintains a 401(k) plan for its employees that has never
been extended to its wholly-owned subsidiary F Company. When the minimum
coverage test is run, including the employees of F Company, the 401(k) plan fails
to satisfy Code §410(b) and, as a result ceases to be tax-qualified.
◦ Correction: NHCEs of Company F must be included as participants on a
retroactive basis and receive a QNEC sufficient to pass ADP/ACP test

SIMPLE IRA Example
◦ Failure: SIMPLE IRAs can be established only by an employer which had no more
than 100 employees who made at least $5,000 for the preceding year. Company
G maintains a SIMPLE IRA for its 80 employees (all whom made more than
$5,000 last year). Company G has a brother/sister affiliate, Company H, which is
a member of the same controlled group as Company G and has 40 employees
who made over $5,000. Because Companies G and H must be treated as a single
employer, Company G is ineligible to maintain the SIMPLE plan.
◦ Correction: Stop employer and employee contributions. File VCP application
requesting that contributions made for previous years remain in the employees’
SIMPLE IRAs.
22
6. Bad Plan Documentation
23
Bad Plan Documentation

IRS definition of “plan document failure”
◦ A plan provision (or absence of a plan provision) that violates Code
qualification requirements
◦ Arises under 2 scenarios:
 New law passes or regulations issued and plan not timely amended
to meet new rules
 Plan not timely amended during remedial amendment period for
adopting good faith or interim amendments
 Interim amendments are required to keep a plan up to date
between remedial amendment cycles

Examples of recent law changes with expired deadline:





Conversion of 401(k) accounts to Roth without distribution
Allowing nonspouse beneficiary distributions via rollover
Allowing suspension of required distributions for 2009
Special benefits for participants w/qualified military service
Faster vesting of employer contributions under PPA 2006
24
Bad Plan Documentation

Correcting Amendment Failures
◦ Adopt amendments for missed tax law changes
 Look for IRS sample language in model amendments and List of
Required Modifications
 Effective date of amendment should be retroactive to conform plan
terms to legislative requirement
 File VCP submission with IRS
 Submission is expected to include the executed amendments that
will correct the failure
 Issuance of compliance statement by IRS results in amendments
being treated as if they had been adopted timely

Avoiding Future Failures
◦ Do annual review of plan document
◦ Designate person responsible for identifying time-sensitive amendments
◦ Use annual cumulative list published by IRS (e.g., see Notice 2012-76)
25
7. Prohibited Transactions
A. Plan Services
B. Bad 408(b)(2) Disclosure
26
Prohibited Transaction and Plan Services

Furnishing goods, services or facilities to plan is a prohibited transaction
unless arrangement qualifies for exemption

Violation results in 15% excise tax and100% tax if not corrected

Four requirements for exemption
◦ Service must be necessary to establish or operate plan
 Necessary means appropriate or helpful
◦ Service contract must be reasonable
 Plan must be able to terminate contract without penalty on short notice
 Plan should not be locked into an arrangement that becomes unfavorable
 Long-term lease is acceptable only if it can be terminated before
expiration
 Minimal early termination fee to allow recoupment of start-up costs is
acceptable
◦ Plan should pay no more than reasonable compensation
 Management Evaluates reasonableness of fees by market rate for
comparable services
◦ Disclosure by service provider
27
Bad 408(b)(2) Disclosure

Regulation effective in 2012 requires plan service provider to
make written disclosures to plan:
◦ Description of services
◦ Whether services to be performed as fiduciary
◦ Compensation to be received from plan and from third parties

Bad disclosure makes service arrangement a prohibited
transaction by plan fiduciary and service provider
◦ Failures can be cured
◦ Plan must make written request for information and provider must
respond within 90 days
◦ Service provider refusal or inability to comply with request for
information requires plan fiduciary to notify DOL
 Plan fiduciary must decide whether to terminate services
 Presumption is termination
 Services to be continued only if prudent
 Good faith mistakes must be corrected no more than 30 days after
provider knows of error or omission
28
8. Illiquid Plan Assets
29
Illiquid Assets

Holding illiquid assets is problematic for an ERISA plan if
◦ Purchased in non-exempt prohibited transaction involving party in
interest
◦ Purchase was an imprudent decision or
◦ It is imprudent for plan to continue to hold the asset

Examples of illiquid assets
◦ Restricted and thinly traded stock
◦ Limited partnership interest
◦ Real estate
◦ Collectibles

Plan fiduciary must determine that asset is illiquid because:
◦ Asset failed to appreciate, provide reasonable rate of return or caused
loss
◦ Sale is in plan’s best interest
◦ Asset cannot be sold for its original purchase price or FMV (if greater) to a
person other than person who is a party in interest to the plan

May correct by selling to related party subject to conditions
30
Illiquid Assets

Conditions of correction by selling to party in interest
◦ Purchase price on sale to party in interest must be greater of
 FMV of asset at time of resale (unreduced by sale costs)
 Original purchase price plus lost earnings under DOL calculator
◦ Qualified independent appraiser must report on Asset’s FMV
◦ Application to DOL
 Documentation of original purchase price to be included in
submission

DOL no action letter
◦ Allows correction or asset’s original acquisition
◦ Permits sale of asset in transaction that otherwise might be prohibited

Example
◦ Plan buys real property from party in interest in 1999 for $60,000. Plan
official makes illiquid asset determination in 2004. In 2004, appraiser
values property at $20,000. Plan sponsor pays plan $60,000 plus lost
earnings and plan transfers real estate to plan sponsor.
31
9. Late Elective Deferrals
32
Late Elective Deferrals

When participant funds become plan assets
◦ Amounts that a participant pays to an employer or amounts that a
participant has withheld from wages must be paid to the plan trust on
earliest date they can be segregated from employer’s general assets
◦ Safe harbor for plans with fewer than 100 participants: deadline for
remittance to trust is 7th business day following day on which the
amount is received by the employer or would have been payable to the
participant in cash

IRS Failure
◦ Employer fails to remit participant elective deferrals by the earliest date
employer can reasonably segregate deferral deposits from general
assets. This will not be an operational failure for VCP purposes if plan
does not have language relating to time contributions are deposited. If
plan has timing language, there will be a qualification failure for failing
to follow plan terms.
◦ Correction: Employer makes contributions with earnings up to date of
correction. VCP submission should describe new procedural safeguards
adopted to ensure that deposits will be timely made.
33
Late Elective Deferrals

DOL Failure
◦ Regardless of plan language, failure to make timely remittance will be a
prohibited transaction for DOL purposes.
◦ Correction: employer required to make delinquent contributions plus
greater of:
 Lost earnings or
 Restoration of profits resulting from employer’s use of the
delinquent funds prior to making contribution
◦ DOL Voluntary Fiduciary Correction Program requires extensive
documentation:
 Narrative of remittance practices and certification by plan official of
earliest date when remittance possible
 Copy of payroll documents showing date / amount of each
withholding
 Relief from submission of documentary evidence if amount is below
$50,000 or delinquency is less than 180 days
34
10. Bad Administration
35
Bad Administration - Loans

Loans - In order for a plan loan to not be considered a taxable
distribution, it must meet certain IRC requirements
◦ Maximum amount of loan
◦ Repayable within 5 years with exception for certain home loans
◦ Level amortization and not less than quarterly payments

Failure 1 - Plan sponsor permits loan in excess of Code limit
◦ Failure - Loan is more than lesser of (a) 50% of vested account balance
(but not less than $10,000) or (b) $50,000 reduced by highest amount
owed on other loans by the participant during prior one-year period
◦ Correction – Participant repays excess amount to plan. Principal
balance of loan reamortized over 5 years from date of original loan

Failure 2 – Loan repayment period more than 5 years
◦ Failure – Loan provides 6-year term
◦ Correction – Plan sponsor can avoid treating loan as taxable distribution
by filing VCP application. Remaining balance of loan at time of
submission would be reamortized so that loan is fully paid by end of 5
years measured from loan date.
36
Bad Administration –
Loans & Hardship Withdrawals

Loan Failure 3 – Repayment Failure
◦ Failure – Employee fails to make loan repayments according to repayment
schedule (e.g., employee’s loan information not forwarded to payroll dept.
which would have implemented repayment by payroll deductions.
◦ Correction - Two alternatives under VCP provide relief from reporting loan
as distribution:
 Participant to repay missed payments plus accrued interest in lump sum
and repay loan balance over remaining loan term or
 Loan may be reamortized over remaining term
◦ If plan provides that a loan does not become deemed distribution until end
of calendar quarter following quarter in which payment was missed, the
cure period may allow administrator to fix problem without VCP or other
negative consequences

Failure 1 Due to Financial Hardship Withdrawal
◦ Failure - Elective deferrals not suspended for 6-month period following
financial hardship withdrawal, as required by the Code and plan terms
◦ Correction – 6 months of improper deferrals treated as current taxable
distribution. File VCP application and distribute deferrals plus earnings.
37
Bad Administration – Hardship
Withdrawals & Eligibility

Failure 2 Due to Financial Hardship Withdrawal
◦ Failure – Employer permits participant to take hardship withdrawal from a 401(k)
plan that does not provide for such withdrawals
◦ Correction – File VCP application requesting authorization to amend plan
retroactively to permit hardship distributions

Eligibility Failures
◦ In general, employees must be allowed to participate in a qualified plan if:
 They have attained age 21 and
 They have at least 1 year of service
◦ Failure - Employer permits employees who have not met its 401(k) plan’s
eligibility conditions to become participants
◦ Correction – Two alternatives
 If prematurely included employees are primarily NHCE, employer may file VCP
submission requesting that plan be retroactively amended to permit their
participation. Impact of amendment must not be discriminatory
 Distribute improper employee deferrals and notify them of their taxability
38
Speaker Biography – Marcia S. Wagner
Marcia is a specialist in pension and employee benefits law,
and she is the principal of The Wagner Law Group, one of the
nation’s largest boutique law firms, specializing in ERISA,
employee benefits and executive compensation, which she
founded over 18 years ago. A summa cum laude and Phi
Beta Kappa graduate of Cornell University and a graduate of
Harvard Law School, she has practiced law for over twentyseven years. Ms. Wagner was appointed to the IRS Tax
Exempt & Government Entities Advisory Committee and
ended her three-year term as the Chair of its Employee Plans
subcommittee, and received the IRS’ Commissioner’s Award.
Ms. Wagner has also been inducted as a Fellow of the
American College of Employee Benefits Counsel. For the
past six years, 401k Wire has listed Ms. Wagner as one of its
100 Most Influential Persons in the 401(k) industry, and she
has received the Top Women of Law Award in Massachusetts
and is listed among the Top 25 Attorneys in New England by
Boston Business Journal.
39
ERISA COMPLIANCE AND ERRORS
Top Ten Mistakes
Marcia S. Wagner, Esq.
99 Summer Street, 13th Floor
Boston, MA 02110
Tel: (617) 357-5200 Fax: (617) 357-5250
Website: www.wagnerlawgroup.com
[email protected]
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