As we previously reported, in May 2010, the Internal Revenue Service (“IRS”) mailed compliance questionnaires to 1,200 randomly selected 401(k) plan sponsors. The compliance questionnaire required the plan sponsor to answer a series of questions within 90 days via secured website about the design of the plan and its actual day-to-day operations. The questionnaire was a “compliance check” and not an “audit” and was designed to provide the IRS with information to gauge the health of the 401(k) universe and better focus the IRS’s future compliance initiatives and educational programs. The IRS expects to provide an interim report in March/April, 2011 and a final report in October/November, 2011.  

Recently, the IRS hosted a phone forum to update plan sponsors and benefits practitioners on the status of the results from the compliance questionnaire and to provide some information on the most common 401(k) plan mistakes that the IRS finds in an audit of a plan. During the forum, the IRS suggested that plan sponsors consider using the compliance check questionnaire as an internal audit tool to identify and correct plan problems before the IRS finds the error and/or to minimize the costs incurred by the plan sponsor in correcting plan error(s). Some of the more common 401(k) plan errors continue to be:

  1. Document Failures: The plan has not been updated or amended to keep up with various changes in the law and/or the amendments have never been signed, which means they have never been officially adopted.  
  2. Definition of Compensation: Whether the plan uses one definition of compensation for all purposes or multiple definitions, the IRS has found that in over 50% of the plans that it has examined, the plan is being administered using a definition of compensation that is not consistent with the plan documents.  
  3. Failure to Include All Employees: Often, there is a misunderstanding regarding the plan’s eligibility requirements, plan entry dates and/or different requirements for employee deferrals and employer matching contributions. Further, some plan administrators assume part-time employees are not eligible simply because they are part-time employees.  
  4. Failure to Timely Deposit Deferrals: Plan sponsors continue to deposit employee deferrals late.  
  5. Participant Loans: The IRS has found (a) loans to participants in excess of the $50,000 maximum, (b) more loans granted than the plan document allows, (c) terms of loans in excess of five years and (d) loans being processed from plans that do not allow for participant loans.  

As we have reported in previous Updates, many of these common plan errors can be corrected utilizing the IRS’s Employee Plans Compliance Resolution System (“EPCRS”). However, as the IRS has correctly pointed out in its summary, the earlier that a plan error is identified the easier and less costly the plan error is to fix. Therefore, to prevent and to minimize plan errors, we encourage all plan sponsors to (a) review their plan documents to ensure that the plan has been updated, (b) refer to the plan documents before making any distributions and (c) coordinate with payroll and any outside third-party administrator to ensure that all parties understand how to calculate compensation for plan purposes.