Late Deferral Deposits: A DOL Hot Spot by Ilene Ferenczy
Situation: Jonathan, the head of his employer’s Retirement Plan Committee, makes sure that the salary deferrals removed from the employees’ paychecks are deposited to the company’s 401(k) plan within 7 business days of payroll. The plan’s auditor says that the deferrals are late. Are they?
Discussion: Department of Labor (DOL) regulations provide that salary deferrals (and also participant loan payments made through payroll deduction) must be in trust as of the earliest date on which such amounts can “reasonably be segregated from the employer’s general assets,” but not later than the 15th day of the month following the month in which they were removed from payroll. This regulation language is misleading, because the DOL ignores the “15th day” rule in favor of the “earliest date” language. The DOL wants the plan sponsor to deposit these payroll deduction amounts either on or immediately after the payroll date. (Plans with fewer than 100 participants have a safe harbor under which deposits within 7 business days of payroll are timely. This does not apply to larger plans.)
How does the DOL judge timeliness?
As a first step, DOL investigators examine the actual deposits historically made by the company to the plan. Commonly, the fastest remittance becomes the bellwether for judging the other deposits, the principle being: if you could act this quickly once, why the delay for other payrolls? Deposits within 2 or 3 days are usually acceptable, but a history of depositing faster can make even this too long a turnaround.
What if the DOL says your deposits are late?
Because the DOL treats late deposits as loans from the plan to the company, the company must pay interest to the plan for the period of use. Furthermore, because these loans are prohibited under the law, the company must pay an excise tax equal to 15% of the interest on the impermissible loan. This excise tax payment must be filed on IRS Form 5330 within 7 months following the end of the plan year.
The interest charged is the greater of the market rate for loans or the amount the plan would have earned had the deferrals been deposited timely. The DOL has a calculator to help determine the interest that can only be used under certain circumstances. Usually, the plan earnings rate is acceptable.
Although interest and excise taxes are usually small, the professional fees to do this calculation and prepare the Form 5330 may be costly. Also, the DOL considers untimely deposits to be a misuse of plan assets and a potential fiduciary breach, which is a harbinger of a poorly administered plan. How does the DOL know? There is a question on the annual Form 5500 (which is signed by the Company or Plan Administrator under penalty of perjury) that asks if all deposits were made on time. A “no” on that question can be an audit/investigation target for both the IRS and the DOL and may be noted in your plan audit.
Our recommendation: Transmit deferrals and loan payments immediately when payroll is processed to stay within the DOL rules. If a payment is late, correct it before the DOL finds it.
Ilene H. Ferenczy, Esq., CPC, APA is the managing partner and thought leader for Ferenczy Benefits Law Center, an Atlanta firm focusing on the practical issues affecting retirement plans, the companies that sponsor them, and the people who service them. She is the author of five books and more than 100 articles about retirement plans and is a former third party administrator.