Understanding and Preventing Retirement Plan Compliance Failures

Timely identification and intervention to correct plan compliance failures is critical to stop the dominoes from continuing to fall and trigger more expansive and costly corrections.

The IRS publishes a list of the top 10 failures that plan sponsors address using the EPCRS Voluntary Correction Program:

• Failure to timely amend the plan for tax law changes

• Using an incorrect definition of compensation

• Excluding eligible employees or including ineligible employees

• Noncompliant plan loans

• Impermissible in-service withdrawals

• Failure to satisfy the minimum distribution rules

• Employer eligibility failure

• Failed ADP/ACP testing not corrected in a timely manner

• Failure to meet top-heavy benefit or contribution requirements

• 415 limit failures

Many of these issues are specific to defined contribution plans, such as loans, employer eligibility failures, and ADP/ACP testing. For defined benefit plan sponsors, there are a few more items I’d add to the list of the most common mistakes that occur in administering plan benefits: 

Defined Benefit Compliance Issue	The Consequences of Plan Compliance Failures
Failure to distribute de minimis lump sum payments from the plan	Not paying out benefits to participants with lump sum amounts that can be distributed without consent violates the plan’s terms, increases the likelihood of becoming a missing participant, and increase a plan’s administrative cost.
Missing participants	Unlocatable participants fail to receive required annual and other periodic communications and may have delays in distributing benefits when due from the plan under the minimum distribution rules. With free internet searches at our fingertips, regulators are less sympathetic to employers making inadequate reunification efforts.
Benefit calculation errors	Mistakes in determining benefits owed lead to the over- or underpayment of benefits to participants. Underpayments can lead to near-term spikes in cash flow and potentially significant administrative costs to make supplemental distributions to affected participants. Recent legislative changes restrict plan sponsors’ ability (or eliminate the obligation) to recoup overpayments.
Suspension of benefits notices	Failing to notify participants promptly as they reach their normal retirement age of the consequences of continued employment can lead to significant actuarial increases on defined benefit annuities and escalating plan liabilities.
Outdated or inconsistent SPDs and other plan communications	Since many plan sponsors are no longer able to apply for a determination letter on a regular basis, SPD updates and timely redistribution may be missed if document restatements are not completed.

Contributing Factors

Mistakes can happen no matter how diligent plan fiduciaries are in administering the employer’s retirement plan. What contributes most frequently to the incidence of errors in plan administration?

M&A activity

Buyers may inherit one or more plans with different eligibility rules, vesting schedules, contribution schedules, or benefit formulas that need to be documented to ensure proper administration or ideally harmonized to minimize the complexity of the overall benefit offerings. Historical documentation from the seller may be sketchy or nonexistent. M&A transactions also lead to changes in controlled group membership for the buyer and seller, which can cause coverage and nondiscrimination testing problems.

Complacency

The business world is busy, and sometimes, if something isn’t on fire, it doesn’t get much attention. Businesses often have senior leaders juggling multiple priorities and may lack dedicated HR or benefits staff. In the extreme case, plan administration matters simply aren’t prioritized due to infrequent activity or lack of desire to handle more mundane activities.

Complacency in plan administration can quietly erode compliance and fiduciary integrity. It could be missing required plan document updates, overlooking opportunities to optimize plan design, or kicking the can on compiling and maintaining complete documentation and plan records. When an issue makes it on the radar, it’s often too late to keep it from becoming a bigger challenge than it would have been if someone were better minding the shop.

Staff turnover

Departing HR and finance personnel who regularly work with an employer’s retirement plans often take with them critical know-how about plan operations, historical compliance decisions, and vendor relationships. New hires may not know where to look for the appropriate documentation or records. With the declining number of defined benefit plans in the private sector, understanding how these programs work and differ from 401(k) plans is a decreasingly prevalent skill set.

This loss of institutional knowledge can lead to errors, missed or conflicting participant communications, or inconsistent interpretation of plan provisions. Plan sponsors may rely heavily on their outside service providers to compensate for this loss of institutional knowledge, and are therefore reliant on the quality of the staff assigned to provide support. It’s important to remember that the fiduciary responsibility to evaluate and monitor vendors’ ongoing performance doesn’t have an exception for maintenance of institutional knowledge, and the more a fiduciary relies on outside vendors the greater the stakes for ensuring the assigned staff have the requisite skills and motivation.

Miscommunication

Shifting many plan administration responsibilities from within the HR and benefits team to outside service providers may make sense for employers. However, doing so requires conscious effort to ensure everyone involved in plan administration is on the same page. Lack of clarity around roles and responsibilities can lead to missed deadlines. Missing or incomplete documentation of plan interpretation and administrative practice matters can lead to errors, incorrect contributions, and various other operational failures.

Practical Tips for Avoiding Operational Failures in Retirement Plan Administration

Plan sponsors and fiduciaries seeking to minimize the occurrence of operational failures in administering their retirement plans can take some basic steps to ensure smooth sailing. 

• Outsource critical functions to reduce reliance on internal staff having specialized knowledge of pension administration and mitigate the loss of institutional knowledge of plan-specific administrative procedures.

• Carefully evaluate the qualifications of the selected service providers and the specific staff assigned to support the engagement.

• Establish clear roles and responsibilities, in writing, across all parties involved in supporting plan administration.

• Create a comprehensive plan administration manual that is available to all parties responsible for ensuring proper plan administration, including in-house personnel and outside service providers.

• Conduct regular coordination meetings between HR, finance, and service providers to address upcoming deadlines and pending issues.

• Maintain a centralized plan administration calendar noting key dates for contributions, communications, regulatory filings, and other administrative requirements.

 Final Thoughts

 Maintaining compliance in retirement plan administration requires vigilance, clear communication, and proactive measures. By understanding common compliance failures and their consequences, plan sponsors can implement preventive practices such as outsourcing critical functions, maintaining clear roles and responsibilities, and ensuring regular communication between all parties involved. These steps will help mitigate risks, reduce errors, and ensure the integrity and regulatory compliance of retirement plans.

Understanding and Preventing Top Compliance Failures.pdf

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