An employer is required to file an annual audit report of its retirement plan with the federal government if the plan has over 100 participants. Form 5500 submissions that omit a required audit report in any year invite penalties of up to $2,063 per day (with no cap). The audit is important because it can detect faulty operation of a retirement plan, which, if left uncorrected, exposes the employer to fiduciary liability and federal sanctions. Lack of proper oversight of retirement plan operations leaves employers particularly exposed to large liabilities that often come as a complete surprise. An experienced auditor can often spot these deficiencies, but employers should have their own systems in place to avoid common mistakes.

Common Mistakes

The following common operational errors among retirement plans. How many apply to your organization?

• Failure to Follow the Plan Document.  Do you know where your plan document is? Did you read it and understand it correctly? Not applying its terms correctly can lay the basis for a claim of breach of fiduciary duty. For example, excluding eligible employees from plan participation is a common error that can be expensive to correct if not caught early, and can expose fiduciaries to personal liability.
• Failure to Follow Participant Investment and Other Elections.  Many plans allow employees to invest their own plan accounts. Failure to follow an employee’s investment direction can subject the employer, as fiduciary, to liability. Failure to follow 401(k) deferral elections and any changes in them can also subject plan fiduciaries to liability.
• Defaulted Loans.  Employers who permit participants to take loans from a retirement plan should monitor the timely repayment of those loans. Failure to do so opens the door to defaults and related fiduciary and tax problems.
• Late 401(k) Deposits.  Plan fiduciaries who do not promptly deposit 401(k) deferrals from payroll to the plan trust are subject to penalties ranging from paying interest to employee accounts on late deposits to federal sentences for embezzlement.
• Discriminating Contributions.  Failure to meet 401(k) and other non-discrimination requirements can subject a retirement plan to disqualification if not corrected. Disqualification results in the immediate taxation of plan assets at ordinary rates. A plan disqualification also exposes plan fiduciaries to potential liability.
• Distribution Errors.  Plan failures include a myriad of distribution mistakes. Failure to distribute plan benefits, distributing benefits too early or too late, distributing to a participant without written spousal consent and failing to honor a QDRO in favor of a participant’s ex-spouse are only a few of the many ways a plan fiduciary can incur liability for benefits distribution mistakes.
• Miscalculating Contributions.  Failing to apply the plan definition of “compensation” correctly means matching and profit sharing contributions are incorrect. Contribution errors can open the door to legal liability for an employer.
• Investment Fees.  Excessive fees charged on plan investments can be the basis of a fiduciary breach.

Improving Operational Oversight

The adoption of the following practices can help fiduciaries improve their oversight of retirement plans and minimize their legal liability for operational mistakes:

• Know your Plan Document.  Fiduciaries should know what the retirement plan says and get help if they do not understand it. Failure to operate a plan according to its terms exposes plan fiduciaries to personal liability.
• 401(k) Deferrals.  Remit 401(k) deferrals to the trust under the plan immediately after payroll. Have a backup team available to step in if your employee in charge of payroll is absent.
• Check Operations.  Set up a system that alerts the fiduciaries to plan deadlines and check plan operations periodically. For example, check payroll systems for the accuracy of the list of plan participants, the implementation of employee 401(k) deferral elections, timely loan repayments, and imposition of proper dollar limits on matching contributions and 401(k) deferrals. Keep vesting records of employee benefits accurate and up-to-date.
• Proper Documentation for Distributions.  Plan distributions for hardships, loans, retirement, disability, death and leaving employment are all events that require proper documentation and careful execution. Make sure that distribution forms are updated, used and followed correctly.
• Institute Procedures for Fiduciary Oversight.  Establish a regular procedure for periodic plan reviews and the documentation of periodic meetings of the fiduciaries to review the plan operations, set investment policies, choose plan investments, monitor investment and other managers, monitor fees, and handle operational concerns.
• Get Help From Experienced Professionals.  Auditing a retirement plan and advising on the meaning of a retirement plan document and plan operations are specialties within accounting and law. Employers should seek the advice of skilled professionals to address questions and concerns in the operation of a retirement plan.

Taking preventative steps in operating retirement plans helps catch mistakes early and limits the legal exposure of the employer and other plan fiduciaries. It also makes the plan audit run smoother, often with better results.