Law Firm Reports 403(b) Compliance Issues

The firm said it found that some plan sponsors did not timely execute a proper plan document, thus risking the possibility that all contributions and earnings under the 403(b) plan will become immediately taxable.  

In addition, some of the plan documents executed lacked material terms. The report noted that the purpose of the plan document is to provide information to employees; consequently, a plan document must disclose material terms, including eligibility critieria, benefits, limitations, contracts available under the plan, and the time and form for distributions under the 403(b) plan.  

Some plan sponsors did not coordinate the language in the executed plan document with the underlying investment contract. Still other sponsors permissibly used multiple documents (insurance policy or custodial account provisions) that, together with other literature, became the “plan document”; yet the terms of the underlying documents conflicted with one another. The result is that, almost immediately, plan operations did not conform to the plan document. From the perspective of the Internal Revenue Service (IRS), the 403(b) plan sponsor has a defect that requires correction.  

Reporting Problems 

Form 5500 and audit problems encountered by the law firm includes: 

• Inability to count proper number of participants. A plan sponsor must count employees who are eligible to contribute into its 403(b) plan, but do not contribute, as “participants” for purposes of Form 5500 (and thus the audit requirement). Department of Labor (DoL) Regulation § 2510.3-3(d) more specifically defines how to perform the count. 
• Poor quality of supporting documentation from 403(b) plan sponsor. 
• Auditors found the quality of personnel file data to be poor or nonexistent. For example, when auditors strove to verify whether the employer was honoring a 5% deferral election, there was no documentation to support the withholding and transmittal of the deferral. 
• Because of the lack of records, some plan sponsors had difficulty determining the location of all of its plan assets, contract balances, and number of former and current employees. 
• Filing Form 55005 without audited financials. Rather than not file the Form 5500, some 403(b) plan sponsors simply filed tax returns without the audit attached. Some plan sponsors did not know an audit was needed. Even if they knew, many did not retain an auditor in time, or the auditor could not complete its work before the filing deadline.

Contribution Timing 

Constangy also reported that it saw problems with late transfers of employee money. The report said that 403(b) plan auditors have found that, even though employers withheld contributions from employee paychecks, the employers did not timely forward the contributions to the vendor who was responsible for investing the money. In some instances, the contributions were only a few days late; but in other cases, the contributions were months late.  

According to the firm, this late deposit issue has been a huge part of the enforcement initiatives of both the IRS and DoL. Both agencies know this is an area of significant non-compliance in the 403(b) context.  

The failure of a plan sponsor to timely transfer employee money is a prohibited transaction under IRS and DoL rules. It is a breach of a fiduciary duty that can result in both civil and criminal penalties, depending upon the severity, frequency, and dollar amounts involved. 

The report noted that the DoL has a voluntary fiduciary correction program available to plan sponsors. Under this program, the plan sponsor will have to contribute the amounts on behalf of employee participants and provide earnings.  

Once a plan sponsor has proceeded under the correction program (and received a “no action letter” from the DoL), it can then attempt to ensure the 403(b) plan’s continued tax benefits with an application to the IRS.