The late deposit of employee 401(k) deferrals is among the most common mistakes retirement plan sponsors make. It is also a top priority of the Internal Revenue Service and Department of Labor to enforce sponsors’ fiduciary duty to ensure that contributions are deposited in a timely manner.
Plan sponsors should have established systems that ensure employee deferrals are transferred to a recordkeeper as soon as possible. But should a failure in that system occur, the error must be corrected through one of two avenues: self-correction or filing through the DOL’s Voluntary Fiduciary Correction Program (VFCP).
Although the DOL has not issued guidance for self-correcting late deposits, it is common for plan sponsors to select this method, in which they must deposit the principal amount of deferrals into plan participants’ 401(k)s, plus lost earnings to compensate participants for the missed opportunity to accrue investment earnings.
Lost earnings may be calculated based on actual earnings, or plan sponsors can estimate lost earnings using the highest-performing fund available to the affected participant, the average rate of return for the plan or another IRS-accepted method.
After participants have been repaid, plan sponsors must file Form 5330 to pay the excise tax, which is typically 15% of plan participants’ lost earnings. Finally, late deposits should be reported via Form 5500.
Plan sponsors may opt to correct late salary deferral deposits via the DOL’s VFCP. To pursue this method of correction, neither the plan nor the plan sponsor may be under investigation by government agencies including the DOL, IRS and Pension Benefit Guaranty Corporation, among others.
The first step in correcting late deferrals through the VFCP is contributing the principal amount of deferrals into plan participants’ 401(k)s, plus lost earnings. When using this method, plan sponsors may use the DOL’s VFCP calculator to tally lost earnings. Plan sponsors must then complete and submit a VFCP application form, which furnishes proof of recompense, along with the VFCP checklist and backup documentation.
The main benefits of selecting VFCP are the ability to use the DOL’s VFCP calculator, exemption from the excise tax and receipt of a “no action” letter from the DOL stating the plan sponsor will not be investigated for the late deposits outlined in the VFCP. The benefits of self-correction are that plan sponsors avoid the time and paperwork associated with the VFCP process.