Avoiding Late Employee Elective 401(k) Contributions

Transferring your employees’ 401(k) contributions to your checking account on payroll dates could save you a headache.

Tired of your auditors telling you that employee elective contributions to your 401(k) plan are late? Upset when the auditors issue that Internal Control Deficiency letter explaining that your failure to timely remit such contributions resulted in a prohibited transaction which needs to be reported to the Internal Revenue Service? Think the auditors are wrong and should back off?

According to the United States Department of Labor, they aren’t, they shouldn’t – and they won’t.

But there is an inexpensive and simple solution.

Head to your bank and open a checking account in the name of your 401(k) Plan. On payroll dates, just as you would routinely transfer funds electronically from your operating account to your payroll account, simply make an additional transfer of your employees’ 401(k) contributions from your operating account to your newly formed checking account.

Unexpected retirement plan disqualification can trigger serious tax problems

Although the funds have not yet been invested, this simple procedure fulfills the timely remittance requirements inasmuch as the checking account is in the name of your 401(k) Plan and, accordingly, constitutes a Plan asset. Most banks do not charge or impose any fees associated with opening a checking account and the mere transfer of funds from one linked account to another can be accomplished with the click of a button.

Companies routinely transfer funds from their operating account to their payroll account to cover gross payroll. From that point, payments are wired from the payroll account to multiple places (i.e. employee bank accounts for net paycheck, the IRS for employee taxes withheld, and the 401k plan for employee contributions withheld). The withholding taxes and 401k contributions generally are processed days after the employees receive their paychecks (which creates the remittance timing issue). By transferring employee contributions from the operating account directly to a checking account in the Plan’s name, this alleviates the remittance timing issue associated with the second wire. The Company can then (days later) initiate the second wire from the Plan’s checking account to the investment company but the timing issue is eliminated.

Some companies do not initiate the wire transfer to send employee contributions to the Plan but rather the Plan administrator initiates the transfer and withdraws the funds from the Company’s bank account. In these circumstances, the Company is at the mercy of the plan administrator as to when the funds are remitted to the plan. In this scenario, the Company would simply direct the plan administrator to withdraw the funds from the Plan’s newly created checking account.

If contributions are deemed late, various administrative filings are required which may be burdensome, time consuming and costly. Additional expenses may be incurred for lost earnings on participant accounts that you, as Plan Sponsor, may be liable for. In addition, the IRS is notified of these actions through filing of Form 5500 which is a red flag that increases your risk for examination.

All of this can be avoided – so be proactive and act now.

Read: Got Multiple Locations? Expect Auditors to Keep a Close Eye on Inventory