Employers: Steer Clear of These Costly Retirement Plan Errors

  • Employer strategies
  • 9/4/2019
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If you’re the plan sponsor for a Simplified Employee Pension or a Savings Incentive Match Plan for Employees, make sure you adhere closely to your plan document terms to avoid costly missteps.

There is a lot to gain by sponsoring a retirement plan for your employees. But when it comes to Simplified Employee Pensions (SEPs), Salary Reduction Simplified Employee Pension Plans (SARSEPs), and Savings Incentive Match Plans for Employees (SIMPLE-IRAs), make sure you understand and follow the terms of your plan document — otherwise, you could end up facing some costly fines.

SEPs, SARSEPs, and SIMPLEs suffer from lack of oversight

The heart of the problem with SEPs, SARSEPs, and SIMPLEs is that they aren’t subject to some of the rules and reporting requirements that apply to 401(k) plans and other IRS-qualified retirement plans. So plan sponsors may not give them the full attention they deserve or even be aware of certain regulations that must be followed, such as testing, limits, and participant eligibility. Employers who adopt SEPs, SARSEPs, and SIMPLEs usually select these plans to reduce the costs and administrative work inherent to typical 401(k) plans.

Generally, these retirement plans are established under the guidance of a custodian or investment provider. But once implemented, the provider often has little to no further involvement, leaving the sponsoring employer to administer the plan on their own. If the plan sponsor unknowingly overlooks key compliance requirements while trying to navigate IRS regulations and interpret plan document provisions, they could make operational errors. If these errors are left to persist for several years, fixing them could result in hefty fines and a lot of additional work.

Errors and compliance requirements

It’s best that you try to get ahead of errors before they occur, but that isn’t always possible. Here are some of the most common errors to look out for in your own employee retirement plan:

  • Eligibility and participation failures (not allowing employees to participate when they become eligible)
  • Plan contribution rules (miscalculation of the annual contributions)
  • Employee salary reduction election rules for SIMPLEs (lack of familiarity with the IRS requirements for initial enrollment of eligible participants)
  • Initial and annual employee notification rules (failure to provide the IRS-required notifications within appropriate deadlines)

Additionally, employers who maintain SEPs that include salary deferral provisions (SARSEPs) may be unaware of the annual testing that is required for these plans. While new adoption of SARSEPs has not been permitted since 1996, many of these plans still exist. And because the testing rules for these plans are different from those that apply to 401(k) plans, employers need to engage a firm with the knowledge necessary to conduct SARSEP testing.

Overlooked SIMPLE and SEP compliance requirements

Employers who sponsor SEPs and SIMPLEs do not engage a third party administrator. And because the provider may not have communicated the rules to the employer when the plan was established, there are compliance requirements that plan sponsors may be unaware of. The IRS does select these plans for examination and will review them for compliance. Here are some common issues that employers who sponsor SIMPLEs and SEPs may not be aware of:

  • Maximum employee thresholds — A company with more than 100 employees is prohibited from sponsoring a SIMPLE, even if it was established when the company’s workforce totaled only 50 people. The IRS has been sending compliance check questionnaires to some employers whose annual W-2 filings exceed 100 employees. In this questionnaire, the IRS requires employers to verify whether they are operating a SIMPLE. If it’s determined that an employer with more than 100 employees is operating a SIMPLE, then contributions must cease immediately.
  • SIMPLE terminations — When an employer decides to switch to a 401(k) plan, the SIMPLE must operate for the entire calendar year. A SIMPLE may not terminate in the midst of the calendar year, and proper procedures must be followed when terminating the plan.
  • Documented corrections — Excess contributions and contributions to ineligible employees may be self-corrected. But if the employer wishes to retain the excess contributions in the individual accounts, formal correction documentation must be submitted to the IRS through its Voluntary Correction Program.
  • Plan restatement — Plans must be updated (restated) from time to time, as required by the IRS. Your provider should alert you prior to applicable deadlines.
  • Transitioning due to a merger — There are special transition rules when two employers merge if one or both companies operate a SIMPLE. Compliance issues will also ensue when an employer adopts both a SIMPLE and a SEP, as one employer may not sponsor both types of plans simultaneously.

Making corrections

There are basically two ways to deal with plan errors if you discover them before the IRS does:

Under the IRS retirement plan correction programs, SEP and SIMPLE errors may be self-corrected if they are considered insignificant. Determination of insignificance is subjective, and is generally based on the dollars involved relative to total plan assets or the number of plan participants affected in relation to total plan participants. When SEP or SIMPLE errors are significant, they can only be corrected with a formal IRS VCP filing.

Because SEP and SIMPLE errors often go unnoticed for many years, a majority of these corrections will probably be significant. Under VCP, errors should be corrected for all years that they existed. This will require you to dig through old records and deal with the significant expense and time that goes into preparing for an IRS submission.

IRS audits may result in consequences

If the IRS audits your plan and discovers errors, it will require that you correct the errors immediately. Or, in rare cases, the IRS will move the process to the Audit Closing Agreement Program (CAP). Under Audit CAP, you’ll need to correct the errors, and then pay a negotiated penalty to the IRS. The IRS states that the penalties will not be excessive and will generally depend on the type and extent of the failures.

If you can’t reach an agreement with the IRS on the correction or the penalty amount under Audit CAP, then your SEP or SIMPLE will be disqualified. Instances of disqualification are rare, but should be avoided at all costs, as disqualification will result in retroactive reversal of favorable tax benefits to the employer and the participants.

Consult the right documentation

Refer to your various plan documents and instructions, as they will serve as your guidelines for operating your plan. Some providers sponsor their own documents, so you should always refer to the document you adopted when the plan was established, or consult these subsequent documents:

How we can help

If you’re unsure about any aspect of your plan, CLA’s retirement plan services team or wealth advisors can help. Our professionals understand what goes into maintaining an employer-sponsored retirement plan and can help you identify errors. We can then work with you to make sure your plan document is up to date, and put measures into place to help you operate your plan and maintain compliance going forward.

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