Mid-Year Reviews to Prevent Year-End Headaches

Jun 02, 2022

Being an advisor to retirement plan clients often requires you to provide more than investment expertise. Your clients also need your help to ensure their plan meets IRS compliance requirements and is prepared for a potential IRS plan audit. This support helps them satisfy their fiduciary responsibility under ERISA by ensuring their plan is operating according to the terms of their plan document.

The IRS is responsible for enforcing the rules that retirement plans must meet to maintain their tax-qualified status. The initial focus in an IRS examination is typically to determine whether the plan document and all required amendments are current. Often, the next step is to determine whether the plan sponsor has operated the plan in accordance with the plan document. This includes ensuring the plan is:

  • Using the correct definition of compensation

  • Making matching contributions according to the formula in the plan document

  • Passing nondiscrimination testing and/or correcting testing failures

  • Enrolling employees in the plan when they become eligible to participate

  • Restricting plan contributions to the statutory limits 

  • Timely depositing employee salary deferrals

  • Properly administering plan distributions and loans

  • Providing required notices and disclosures to participants

Plan sponsors typically rely on recordkeepers and third-party administrators (TPAs) to help with plan operations. But plan sponsors must understand they are ultimately responsible for making sure their plan complies with all IRS requirements. You can educate plan sponsors about their compliance responsibilities and how they can develop and implement processes and procedures to drive operational compliance.

Review Plan Document 

To avoid plan document failures, the IRS recommends plan sponsors ensure they have a complete, signed set of plan documents in a plan file. Signed copies of the original plan document and adoption agreement and all required and optional amendments should be retained. 

Plan sponsors should also periodically review their plan document to make sure they have a solid understanding of the features of the plan. This is essential to making certain that the plan is being operated according to the plan terms. Plan sponsors may want to take detailed notes on sections of the plan document that define specific plan operations and provide those to internal staff responsible for certain aspects of plan operations. For example, the definition of compensation for determining plan contributions selected in the plan document should be provided to the payroll staff responsible for withholding or calculating plan contributions. 

Audit Plan Operations

The IRS believes that proactive self-audits of plan operations are vital for maintaining compliance with the tax code and recommends that plan sponsors conduct periodic plan check-ups. A self-audit will help plan sponsors identify any compliance missteps that have been made, so they can correct them before they pose a bigger risk to the qualified status of the plan. For example, a self-audit may uncover that some employees who were eligible to enter the plan were not notified of their plan eligibility, or that employee bonuses were incorrectly excluded from compensation used to determine employer contribution allocations. 

Correct Operational Errors

If a plan sponsor discovers a compliance problem, the IRS offers a correction program that allows the plan sponsor to correct the mistake and preserve the plan’s tax-favored status – the Employee Plans Compliance Resolution System (EPCRS). EPCRS is designed to improve overall plan compliance by helping plan sponsors voluntarily correct plan compliance errors without penalty or at a significantly reduced cost as compared to corrections made after an IRS audit. 

Implement Internal Controls

In addition to recommending self-audits to find and fix plan mistakes, the IRS recommends that plan sponsors establish internal controls to ensure their plan is operating in compliance with their plan document and the tax laws that apply to retirement plans. By establishing formal procedures for monitoring plan operations, plan sponsors can identify or prevent mistakes and reduce the scope and duration of a potential IRS examination. The IRS provides examples of internal controls: 

  • Compare salary deferral election forms with the amounts deducted from employees’ wages
  • Verify the types of compensation used for allocations, deferrals, and testing
  • Check that plan service providers received accurate compensation and ownership records
  • Monitor annual contribution and compensation limits
  • Verify the validity of rollover contributions accepted into the plan
  • Verify that years of service were accurately determined for eligibility and vesting
  • Verify marital status and spousal consent for plan distributions
  • Ensure participants received required minimum distributions

In addition to developing processes and procedures for monitoring retirement plan operations, plan sponsors and staff should document when and how the procedures are followed to maintain consistency over time and demonstrate compliance. These records should also be retained in the plan file.

Advisor Action Steps  

Developing and executing on a proactive compliance strategy can provide peace of mind to plan sponsors that their plan is operating properly and can help lessen the scope of a potential audit. You may want to include these compliance support service in your business model:  

Educate plan sponsors about their compliance responsibilities: Help plan sponsors understand the IRS requirements to maintain tax-qualification of their plan. Make sure they understand their role and potential liability as compared to their service providers. 

Help plan sponsors design a compliance strategy: Start with a document review. Make sure plan sponsors have a plan file with executed plan documents and amendments and remind them of the importance of understanding their plan’s features and terms. You can also help them review the scope of compliance support services provided by the plan’s TPA or recordkeeper and the plan reports they receive that can help them keep an eye on compliance issues. Next, guide plan sponsors in developing a plan for conducting regular internal audits. This should include a list of tasks to be performed, assignment of responsibility for completing audit tasks, and a timetable for completing each task. The IRS’s 401(k) Plan Checklist and 401(k) Fix-It Guide can be used to design a plan audit. These resources help plan sponsors understand what to audit, how to determine if a compliance mistake has occurred, how to fix the mistake, and how to prevent future mistakes. Armed with the results of the self-audit, you can use the IRS’s  list of questions to help plan sponsors evaluate their plan procedures and develop specific internal controls in the following areas of plan operations: plan service providers, employee eligibility, contributions, distributions, plan testing and plan administration (e.g., participant notices, Form 5500). As a list of processes and procedures is being developed, make sure plan sponsors designate a schedule for performing each internal control task (e.g., every payroll, quarterly).

Be a gateway to other resources: Work with the plan sponsor’s service provider team to define roles and responsibilities and facilitate communication with the plan sponsor. You can also help plan sponsors identify resources for plan document and design consultation, as well as plan corrections such as a TPA or an ERISA attorney.

This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before making any decisions. Newport and its affiliates do not provide tax, legal or accounting advice.

Newport Group, Inc. and its affiliates provide recordkeeping, plan administration, trust and custody, consulting, fiduciary consulting, insurance and brokerage services. 20220526-2216789

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