correction of delinquent remittance of employee contributions Allocating contribution to correct late employee contributions

[Luke Bailey]

So say you have a fairly large 401(k), 100's of employees, a few million dollars in deferrals ever year, $100k or so in deferrals each payroll period. CPA says that employee contributions should have been made, say, within 2 days of payroll date. That's reasonable. Most were, but some were made 3, 4, 5, or in one case 8 days later. Out of 24 payroll dates, maybe 10 have a problem. You calculate the lost interest and it is, say, in the 10's of dollars for each payroll, maybe $1,000 for the entire year.

DOL's VFCP Notice says the correction is to contribute the "Lost Earnings," but does not elaborate further. So good, you contribute the $1,000. My question is, how do you allocate it? The lost earnings arguably should be allocated as of each payroll date that had a late contribution, to the accounts of the participants who deferred on that date, in proportion to their deferrals. This will result in hundreds of separate allocation amounts, many less than one dollar. The administrative expense of doing that may easily exceed the amount being allocated. And some of the participants will have left and already cleared out their accounts.

Assuming your plan document can be interpreted to permit this and it passes nondiscrimination, can you do something different, like allocate per capita to anyone who (a) deferred during the applicable year, e.g. 2017, and (b) still has an account in the plan?

I am aware of the recent EBSA regional office letter urging employers to use the formal VFCP process, even for small amounts, rather than self-correcting, so my question is not directly about that, although maybe that is involved because if you go through the VFCP process you could get your short-cut allocation method approved by EBSA?

If you've heard this one before and it's got an answer, just point me to it. Thanks in advance.

[RatherBeGolfing]

15 hours ago, Luke Bailey said:

My question is, how do you allocate it? The lost earnings arguably should be allocated as of each payroll date that had a late contribution, to the accounts of the participants who deferred on that date, in proportion to their deferrals.

There really isn't another reasonable option.  Each late deferral is entitled to the lost earnings associated with that deferral.

 

15 hours ago, Luke Bailey said:

Assuming your plan document can be interpreted to permit this and it passes nondiscrimination, can you do something different, like allocate per capita to anyone who (a) deferred during the applicable year, e.g. 2017, and (b) still has an account in the plan?

No.  It is pretty clear that you can't give the lost earnings owed to one participant to another participant, simply because it is more convenient.  Doing so would not make the participant who suffered the loss whole, which I would interpret as an incomplete correction.

15 hours ago, Luke Bailey said:

I am aware of the recent EBSA regional office letter urging employers to use the formal VFCP process, even for small amounts, rather than self-correcting, so my question is not directly about that, although maybe that is involved because if you go through the VFCP process you could get your short-cut allocation method approved by EBSA?

You could try, but I have seen more reasonable "short cuts" shot down in VFCP applications in the past.

What I have done on VFCP apps with 100s of participants in the past is to calculate the lost earnings for each payroll as a whole, and then attaching a spreadsheet allocating the earnings for each late payroll date proportionate to each participants part of the total late deferral for the payroll date.  It cuts the actual lost earnings calculations down to the number of problem payrolls rather than for each participant, and the spread sheet is pretty simple to set up.

The bigger problem is what do you do with the participants who have left, and now have a balance of less than $1.  If possible, I would ask the plan sponsor to eat the distribution cost and send the participants what they are owed.  Of course, that may create another issue with lost or recalcitrant participants, but I think that is a separate discussion.

[Luke Bailey]

RatherBeGolfing, I really appreciate your response. That's what I told the client the last time, but I got (and am getting again) significant pushback from the trustee, via the client. The trustee is a large bank with a significant ERISA presence, and the client indicated that the trustee was surprised it was being asked to do such small allocations. Last time and this time I was somewhat surprised both that there did not seem to be any guidance on this, and at getting pushback from the trustee.

I find it somewhat perplexing that the DOL in its VFCP release says that the employer has to contribute the total of the missed earnings, but doesn't go the next step and state how that interest must be allocated. Just one sentence in the release would have cleared the whole thing up.

I think you are very likely 100% right about this, though, and unless another commenter comes up with something different and authority to base it on, this is what I will insist the client does. Your explanation was, again, very helpful. Thank you.

[Larry Starr]

13 hours ago, Luke Bailey said:

RatherBeGolfing, I really appreciate your response. That's what I told the client the last time, but I got (and am getting again) significant pushback from the trustee, via the client. The trustee is a large bank with a significant ERISA presence, and the client indicated that the trustee was surprised it was being asked to do such small allocations. Last time and this time I was somewhat surprised both that there did not seem to be any guidance on this, and at getting pushback from the trustee.

I find it somewhat perplexing that the DOL in its VFCP release says that the employer has to contribute the total of the missed earnings, but doesn't go the next step and state how that interest must be allocated. Just one sentence in the release would have cleared the whole thing up.

I think you are very likely 100% right about this, though, and unless another commenter comes up with something different and authority to base it on, this is what I will insist the client does. Your explanation was, again, very helpful. Thank you.

I always find that when we get "pushback" of this sort from some organization or practitioner where what they are doing is wrong, asking them to PUT INTO WRITING what they think the answer is and give citations usually makes the issue go away.  A practical answer that is amazingly helpful almost all the time!

[Peter Gulia]

Consider also that expenses made necessary because of a fiduciary's breach are expenses that might be included in the breaching fiduciary's ERISA section 409 liability to make the plan whole.

 

[Luke Bailey]

Larry Starr, thanks. I suspect they will say this was their answer as well.

Peter, your point helps a lot with the justification of expense.

[CJ Allen]

I've always been sure to treat the violation as a 'Plan' violation that must be cured in a reasonable manner.  In that instance, the plan is owed earnings on the missed opportunity of having the contributions invested more timely.  Since participant contributions and loan payments are impacted, it would be reasonable to allocated to participants who had contributions in those payrolls.  However, remember the DOL and IRS have found it reasonable to allocate certain amounts to participants who currently have an account balance in the plan.  Of course, allocating to participants with account balances may not be reasonable if the plan is undergoing termination and has few accounts remaining (especially if accounts are for HCE/Key EEs).

[RatherBeGolfing]

35 minutes ago, CJ Allen said:

I've always been sure to treat the violation as a 'Plan' violation that must be cured in a reasonable manner.  In that instance, the plan is owed earnings on the missed opportunity of having the contributions invested more timely.

If I lost out on $10 in earnings because the plan sponsor did not deposit what it withheld from my paycheck, how can giving Dave $10 be a reasonable correction?

 

[Luke Bailey]

CJ Allen, thanks. I tend to agree with RatherBeGolfing at this point, but I recognize your points. It's odd to me that (a) the DOL guidance from 2006 did not include an allocation rule, and (b) 12 years later there does not seem to be an accepted, obvious answer to the question that has emerged from practice..

[CJ Allen]

I respect all of the arguments, and all are plausible.  From doing very many of these for independent audits, IRS audits and DOL complaint resolution, it really comes down to the actual plan and situation at hand.  Regardless of what tends to be common sense, the funds are plan assets and there's no real prohibited transaction except the plan loan to the sponsor.

There's been situations where going back 3 years and over 150 payrolls, it was allowed to be allocated on all contributions during the years in question for all participants currently in the plan as 'reasonable'.

I don't necessarily opt for one process over another as long as reasonable.  In my last RK firm, accounts under $5 for terminated individuals were forfeited each year due to administrative expenses exceeding the benefit to the participant (i.e., distribution fees).  In this instance, any plan with forfeitures used to reduce employer contributions, could be inuring to the benefit of the employer indirectly.  Additionally, if the RK charges a per participant fee, the fee for each newly reopened account could far exceed the earnings allocated.

[Luke Bailey]

Thank you, CJ Allen. I think a client who has this issue and goes through the formal VFCP process can probably try something practical and creative. However, if they are self-correcting, they would probably not be able to take the risk.