Compliance When It’s Tough

Art by JooHee Yoon

Under normal circumstances, running a retirement plan requires attention to detail to avoid mistakes, but in today’s environment the task is even trickier. Consider the wildly fluctuating investment market, companies and staff learning new processes in order to work remotely, the new regulations for loans and distributions.

In addition, plan sponsors’ benefits departments may be stretched thin, potentially dealing with layoffs, employee health issues and reduced revenue. Worrying about retirement plan compliance may not be their top priority.

This makes it even more important for advisers to discuss potential plan errors with their clients, working with them to find and correct any issues—and to avoid them in the first place. The Department of Labor (DOL) has said that it would offer some leniency to plan sponsors that, due to COVID-19, fail to follow certain procedural requirements.

But that does not mean a sponsor can sidestep correcting the issues or showing a good faith effort to remain compliant.

“At the end of the day, even now, the DOL and the IRS are still conducting examinations and audits,” says David Kaleda, a principal with Groom Law Group and a columnist for PLANADVISER. “It’s not like the regulators have gone away.”

Even if clients lack the budget or desire for a full-blown self-audit, the adviser can examine the most common areas that crop up during IRS or DOL investigations.

“Typically, it’s a lot cheaper to fix an error before a regulator sees it, rather than after,” Kaleda says. “A self-correction is the way to go, if you can.”

What follow are five key operational processes that plan sponsors legally must always adhere to, observations about the impact the current situation may be having on how the sponsor follows through, and suggestions for remedying the issues that may arise.

1) Contributions

According to law, a plan sponsor must withhold employees’ retirement deferrals from their paychecks and deposit the funds—as well as its own contributions—into the retirement trust or participants’ individual accounts as soon as is reasonably possible. Plans with fewer than 100 participants have a seven-day safe harbor to make the transaction.

What has changed. With many plan sponsors’ human resources (HR) departments and their payroll providers suddenly working from home, it may be impossible to carry out established procedures in the same way an employer has in the past. It is important for plan sponsors to confirm they have implemented new procedures to ensure all contributions still get deposited as quickly as possible, says Ari Sonneberg, an ERISA [Employee Retirement Income and Security Act] and employee benefits attorney with The Wagner Law Group in Boynton Beach, Florida.

“Plan sponsors, advisers and recordkeepers have to be in touch regularly during this time, more than they would otherwise, to make sure things are running smoothly,” Sonneberg says. “Things aren’t normal. You have employees who have been laid off who may have been overseeing part of the plan. You have to make sure those processes go forward and someone is there to pick up the slack.”

Another contributions-related issue that a plan adviser should discuss with clients is any staffing cuts. That is, if a client lays off more than 20% of its workforce, the IRS may view that as a partial plan termination, which requires immediate, full vesting of all participants. Furloughs, however, typically would not trigger a plan termination, Kaleda says.

2) Employee Eligibility for Participation

Plan sponsors must make sure they admit all eligible plan participants, according to the terms of the plan. Employers requiring a service period of up to a year prior to eligibility need to track how long an employee has worked—either by hours or elapsed time—and communicate with that employee as soon as he becomes eligible about when and how he can enroll.

“One thing that’s paramount to operating a retirement plan is knowing what the conditions are for participating and what happens when people cross certain thresholds,” says Rachel Faye Smith, a partner in Goodwin’s ERISA and executive compensation practice in Boston. “What happens when people add hours or lose hours or get put on employer-mandated leave? Each of those has an impact on eligibility to participate in a plan.”

What has changed. There is more room for errors as companies make changes to their workforce. Furloughed workers might continue accruing eligibility service, even though they are unable to contribute to the plan without receiving compensation, Kaleda says.

“Work reductions, like a reduction in hours, could slow down eligibility for the plan, depending on how the plan counts eligibility service,” he adds.

3) Distributions

To remain compliant, plan sponsors must have clear processes to confirm participant eligibility for loans or hardship withdrawals, and to make sure their employees borrow no more than regulations permit. Plan sponsors must also alert participants to their need, if any, to take required minimum distributions (RMDs) and then facilitate those distributions.

“Plan violations concerning distributions occur somewhat frequently in a few different forms,” Smith says. When violations occur in a plan loan, “either they’re extending plan loans to people who aren’t eligible or who have hit the maximum number of loans, or the administration of loans gets out of line with what the plan document says.”

What has changed. The Coronavirus Aid, Relief and Economic Security (CARES) Act, passed earlier this year, includes several new rules addressing distributions, which plan advisers should discuss with sponsor clients.

If plan sponsors choose to, they may allow any participant—spouse included—who can demonstrate an “adverse financial consequence” from COVID-19 to take a coronavirus-related distribution (CRD) of the lesser of $100,000 or 100% of the balance from the participant’s workplace retirement account. The usual 10% withdrawal penalty is waived. Participants have three years to restore the funds or pay income taxes on them. The legislation also increased the maximum loan amount.

Plan sponsors that opt to make such distributions available must inform participants about whether they are eligible and then be available to answer questions and facilitate both the distributions and their potential repayment.

Additionally, the coronavirus relief act suspended RMD requirements this year, after the SECURE Act pushed the age of mandated RMDs to 72.

4) Plan Testing

Sponsors of a non-safe-harbor plan must run annual tests to make sure their plan is not top-heavy and does not discriminate in favor of the highly compensated employees (HCEs). If a plan fails the testing, the sponsor must either refund excess distributions to the HCEs or make additional contributions on behalf of other workers.

“If a plan sponsor is working with a recordkeeper that provides the testing and is on top of it, [that provider] will usually indicate to the sponsor if it looks like it’s going to fail and allow it to take corrective measures,” Smith says.

What has changed. Employers that are furloughing workers, reducing wages, and cutting or suspending their employer match to 401(k) plans are likely also changing their actual deferral percentage (ADP) or actual contribution percentage (ACP).

In addition, plan sponsors that suspend safe harbor contributions will also now have to perform top-heavy testing, so it is important for plan advisers to talk through the ramifications of such decisions with their clients, says Dave Ragona, director of retirement operations at Human Interest, a firm that provides automated 401(k) plans, in San Francisco, California.

“When you take the safe harbor away and top-heavy testing comes back, it can end up costing a lot more money,” Ragona says. “If you’re doing it to save money, it can be counter-productive.”

5) Plan Document Adherence

For plan sponsors, one of the most basic tenets of operational compliance is adherence to plan documents. That means making sure the documents reflect both current regulations and company policy. Any changes to plan policies typically require plan amendments as well as notification of plan participants.

“Even if what you’re doing is legal under the tax code, if it doesn’t conform to the plan documents, you’re still doing it wrong,” Ragona says.

What has changed. Due to COVID-19 restrictions on travel and gatherings, plan sponsors may not be able to hold the retirement plan committee meetings required by plan documents in the same, in-person way they have in the past, but they still need to have those meetings, even if doing so virtually.

Almost one-third of sponsors answering a PLANSPONSOR pulse survey, which targeted respondents to the 2019 PLANSPONSOR Defined Contribution (DC) Survey, said they discussed reducing or suspending their matching contributions; 34% of the nearly 33% had already acted or are likely to do so.

Plan advisers should also make sure that sponsors make necessary amendments to their plan documents right now, including with regard to matching contributions or changing policies that speak to eligibility of new hires.

One exception: Changes to distribution rules under the coronavirus relief package do not require an amendment to plan documents until end of plan year 2022.

“That’s crazy for all of us in the industry who have been taught that you have to administer the plan according to the document terms,” says ERISA attorney Fred Reish of Faegre Drinker Biddle & Reath LLP in Los Angeles, and a columnist for PLANADVISER.

“But, on this occasion,” he continues, “you can make an administrative decision—which has the same effect as making the amendment—today, but you don’t have to draft and sign the agreement until 2022.”

To limit mistakes, however, plan sponsors should still keep records of when and how they implement such provisions. “Get it recorded in a memo or in a committee meeting, so that, when everyone consciously makes a decision, you have something in writing to refer back to,” Reish says. “That would be a big part of operating this correctly.”