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401(k) Fix It #2

You didn't base the plan operations on the terms of the plan document. 

You didn't base the plan operations on the terms of the plan document. 

The plan sponsor/employer is responsible for keeping the plan in compliance with the tax laws; however, there may be many employees, vendors and tax professionals servicing your plan. 

You should convey any changes made to your plan document or to your plan’s operation to everyone who provides service to your plan. For example, if you amend your plan document to change the definition of compensation, you should communicate that change to everyone involved in determining deferral amounts withheld from employee pay, performing your plan’s nondiscrimination tests or allocating employer contributions. Also, if you decide to use a different definition of compensation in operation, make sure you amend the plan timely to reflect that change. Below are some common changes requiring due diligence to identify any potential mistakes:

  • If you made changes to your plan document, inform everyone who services your plan of those changes and what the changes mean to your plan’s operation.
  • If you amend your plan document, you should also amend your summary plan description. If you materially modify your plan, you must give a summary of the material modifications to plan participants within 210 days after the end of the plan year in which you adopted the modification.
  • If you’ve changed the way you operate your plan, communicate those changes to everyone who provides service to your plan. You may need to reflect these changes to your plan document through a plan amendment.
  • If you’ve changed the plan trustees, you need to convey those changes and you may need to update your plan document and summary plan description.
  • Any changes in the ownership interests or business acquisitions may affect the nondiscrimination testing for the plan. Convey these changes to your plan service providers.

How to find the problem

You must be familiar with your plan document to be able to determine if you've operated it according to its terms. Following the plan document terms is crucial to ensure tax-favored treatment of the plan and to prevent a breach of fiduciary duty under ERISA. Be familiar with the plan document wording and how it affects the plan operation. Conduct an independent review of your plan and its operation annually. If you operate your plan using a summary, check the requirements and definitions on that sheet to make certain they correspond to the plan document. Consider conducting a 401(k) plan check-up using the 401(k) plan checklist 

Client Centered

How to fix the problem.

If you find an error in the operation of your plan, correct it as soon as possible. Use a reasonable correction method that places affected participants in the same position they would have been in had the mistake not occurred. Revenue Procedure 2019-19, section 6 provides general correction principles you should use in determining an appropriate correction method. 

Correction Programs Available

Self Correction Program

If there is a discovered operational problem because the employer didn't follow the plan terms by improperly vesting in the employees' account. And, if the eligibility requirement of the the Self-Correction Program are satisfied, then the employer may use the Self-Correction Program to correct a mistake. 

  • There are generally no IRS imposed fees for self-correction.
  • Practices and procedures must be in place for its use.
  • If the mistakes are significant in the aggregate:
    • The employer needs to make corrective contribution to the plan and have the Plan make a distribution to the employee in a timely manner, generally two years. The timing will be calculated when the mistake is discovered and corrected.
    • If the error is not corrected in a timely manner, the employer isn't eligible for the Self-Correction Program and must correct under the Voluntary Correction Program.
  • If the mistakes are insignificant in the aggregate, The employer can take corrective actions to fix the mistake beyond the two-year correction period for significant errors. Whether or not a mistake is insignificant depends on all facts and circumstances.

Voluntary Correction Program:
Correction is the same as described above under Self-Correction Program. If the plan is not under audit, the employer makes a Voluntary Correction Program submission to the IRS according to Revenue Procedure 2019-19, Section 11 via the website. When making the VCP submission, The employer should consider using the model documents set forth in the Form 14568 series (i.e. Form 14568, Model VCP Compliance Statement & applicable Schedule) to resolve some common operational problems. Otherwise use Form 14568 and custom narrative attachments to describe the problem and how it’s been fixed. User fees for VCP submissions are generally based on the amount of plan assets.

Audit Closing Agreement Program:
Under the Audit Closing Agreement Program, a correction is the same as described above under SCP. The employer and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction The sanction under Audit CAP is based on facts and circumstances, as discussed in Section 14 of Revenue Procedure 2019-19.

How to avoid the mistake:

  • Be sure to apply the provisions of the plan correctly when making a determination of what contributions or benefits are provided to participants. Develop a way to communicate changes timely and accurately to plan administrators and outside service providers (outside plan consultant, actuary and/or third party administrator/record keeper).
  • Have a clear process for making distributions. This process should include the plan procedures for ensuring appropriate authorization, accuracy and timeliness. Identify a team responsible to oversee payments.
  • Establish protocols and an action plan to use when errors are identified including the appropriate actions to resolve the errors.
  • Identify the plan trustees as well as the procedures for tracing cash contributions and agreed-to receipts by the trust custodian.
  • Clearly identify the custodian of trust assets including procedures for maintaining trust asset data, communication mechanisms for transferring trust asset data to the trustee, and the reconciliation process including how to deal with errors.

Content Library:

Fix It #1: You haven't update your plan within the last few years to reflect recent law changes.

Fix It #3: You didn't use the plan definition of compensation correctly for all deferrals and allocations. 

Fix It #4: Employer matching contributions weren't made to all appropriate employees.