Top Audit Findings of the 2021 Plan Audit Season

December 7, 2021

With the passing of the October 15 calendar year plan 5500 reporting deadline, and the conclusion of another plan audit “busy season,” we revisit the most common compliance issue we encounter in our work. This season we have our usual suspects at the top of the list, with a COVID twist.

Improper definition of compensation

The plan document specifies the definition of compensation to be used as the basis for contributions to the plan, which includes employee deferrals as well as employer matching or profit sharing contributions. The most common failure we see is the failure to follow this definition in operation. Often this results from improper set up in the payroll system of compensation codes – either including codes for deferral purposes that the definition says should not be included (i.e. severance) or excluding codes for deferral purposes that are not listed as exclusions in the definition (perhaps bonuses or commissions). This past season we saw numerous instances of new codes set up to capture COVID related compensation that were not set up properly with respect to retirement plan withholdings. Errors are also common when checks are cut outside of normal payroll – such as manual checks – and are not set up for normal deductions. Corrections are generally necessary as a result of definition of compensation errors.

Misapplication of IRS compensation and deferral limits

For the 2020 calendar year, the IRS compensation limit was $285,000. The deferral limit was $19,500, or $26,000 including catch up contributions. Payroll systems are often set up in a variety of ways to monitor these limits. Some systems cut off deferrals and match when a participant reaches the compensation limit, whether or not the individual has reached the deferral limit. Some systems cut off only match. Some systems don’t cut off either. Some systems only consider pre-tax and not Roth. Plan sponsors should understand that the compensation limit is an annual limit that affects employer contributions only, however, some plan documents provide effectively for the application to the first $285,000 of compensation earned. It is important to understand your plan provisions in this regard. We found multiple instances where participants were undermatched or overmatched due to misapplication of these limits. We also had multiple instances where participants were precluded from reaching the deferral limit because their deferrals were stopped when they reached the compensation limit. In some cases we continued to see deferrals limited to the prior year limit amounts because the payroll system was not updated for the new limits. The proper set up of any limits in the payroll system should be revisited annually.

Late remittances

ERISA stipulates that employee contributions be treated as plan assets as soon as they can reasonably be segregated from the employer’s general assets. The Department of Labor (DOL) expects these amounts to be remitted to the Plan as soon as they are segregated, but in no event later than the 15th business day of the following month. For most plans, the expectation is that the remittance can occur within a small number of days after payroll is paid. We continue to see instances of late remittances for a variety of reasons. Often this is due to out-of-cycle payroll runs not being remitted immediately. While there was some COVID related relief provided for certain late remittances, we noted most instances we observed had nothing to do with COVID. In our experience, the best monitoring a sponsor can do is to track every pay period, noting the payroll paid date, the amount from the payroll register and the amount actually remitted and the date remitted. Any differences in amounts remitted (and confirmed received by the custodian) should be documented (and if due to amounts incorrectly withheld, evidence of correction in payroll or refund retained). The reason for any delays should also be documented. Lost earnings should be calculated and remitted when it is determined that the amounts could have been remitted sooner.

Vesting Errors

We continue to see situations where distributions are issued based on incorrect vesting. In most situations this is due to errors in the data provided to the service provider. When the hours method is used, it is crucial that the proper hours be supplied to the provider. The accuracy of dates of hire and termination are also critical, especially if you have rehire situations. We recommend a review of all distributions made from the plan for proper vesting. Any time you change vesting methods or schedules, it is also important to ensure the provider is considering the previous methods and schedules for those who terminated while those methods/schedules were in effect.

Mishaps with Deferral Election Changes

Most of our clients are using providers that enable plan participants to make deferral elections on-line directly with the provider. The provider then communicates the election to the plan sponsor, who updates the payroll system accordingly, either manually or electronically. We saw a variety of issues with this process. For manual processes, these errors included the notification being missed entirely (and no change processed), errors in the processing due to mis-keying amounts or source (i.e. coding a change as pre-tax vs. Roth or vice versa), or changes made without written support at all (such as verbal requests or those with payroll access making changes to their own elections directly to the system). In electronic updates we often see automatic changes to withholding of terminated participants to zero even though final compensation has not yet been paid. This results in missed deferrals. Regardless of the process, we recommend a secondary level of review of this activity to prevent and/or detect errors.

Auto Enrollment

Auto enrollment issues continue to plague many clients. Administering automatic enrollment and automatic escalation features can be challenging, and it is important to periodically check how this is working in operation for your plan. The ability for these features to work effectively is contingent upon the accuracy and timeliness of information provided to those responsible for executing the provisions. New employees must be entered into the system timely with accurate demographic data. Notifications from the provider to begin withholding need to be processed timely, but NO EARLIER than the employees’ proper entry date. Rehires might need special treatment with respect to auto enrollment. Escalations need to be programmed to occur on the timeline specified in the plan provisions. We see issues with all of these parts of the process, with the most costly being missing someone for automatic enrollment altogether. Periodic audits of those not contributing to the plan, by comparing payroll records to the provider’s record of those with zero elections on file, can assist in the timely identification of those who are missed.

Eligibility of Part-Time or Seasonal Employees

Though fewer in number, we did see a few situations this year related to improper exclusion of part-time or seasonal employees. There are some plans that exclude these classes of employees altogether, many that provide for participation only after 1,000 hours is reached in a plan year, and others that do not exclude these employees from the plan. We most commonly see issues when there is no exclusion, but these individuals are not offered enrollment. This can result in sizable corrections if the population of such employees is high. Care should be given to clearly understand your plan provisions and ensure actual operations match these provisions.

Failure to Start Loan Repayments Timely

Most processes involving loans are handled by outsourced payroll providers, such that participants request the transaction online, it gets approved electronically, the check is issued to the participant and the amortization schedule is provided to the plan sponsor to set up repayment in the payroll system. We continue to see instances where the notification to the sponsor is missed and the repayment is not set up – resulting in unnecessary default of the loans. A procedure should be established to compare the list of loans issued in a month to the payroll system to ensure repayments have been properly set up. If repayments were missed, discuss reamortization of the loan with your provider to ensure compliance with IRS rules.

General Lack of Evidence of Controls

Our most common recommendation to our clients involves documentation of the execution of controls over the review of plan transactions. Often many of the steps are performed by one individual with no review, and/or a tendency to rely entirely upon the outside service provider. Regardless of who is processing the transaction, a second level of review should be established to review that activity for accuracy or reasonableness, and a record of that review should be maintained.

We know staying on top of all the rules and regulations covering retirement plan compliance can be difficult. Please feel free to reach out to any of us at any time if you have questions regarding operating your plan in compliance with the plan provisions.