Sponsoring a workplace retirement plan is hard. Complying with ERISA regulations, understanding fiduciary responsibilities, and staying up to date on the ever-changing tax law are just a few of the challenges plan sponsors have to navigate. Because of these challenges, it’s not uncommon for plan sponsors to make mistakes. But as many of our clients know, making a mistake as a sponsor of a qualified retirement plan can result in significant consequences, whether it be penalties, fees, or losing qualified status altogether.
Retirement plan sponsorship is fraught with peril, which is why we’ve put together this two-part guide that outlines the eight most common mistakes made by plan sponsors and what you can do to avoid them. We’ll cover the first four mistakes in this article with a follow-up article next week.
1. Misunderstanding Employee Eligibility
One of the biggest mistakes we see with retirement plan sponsors is misunderstanding which employees are eligible to participate in the plan and when. This can be a big issue when it comes to maintaining ERISA compliance, since plans have to cover a certain number of non-highly compensated employees to be considered nondiscriminatory and avoid penalties.
As a plan sponsor, you are probably familiar with the rule that states most employees become eligible to participate in a qualified retirement plan after reaching age 21 and working for at least one year (1,000 hours). (1) But were you aware of the legislative change that significantly updated plan eligibility requirements in 2019? The SECURE Act now requires that long-term part-time employees, those who work between 500-999 in the last 3 consecutive years, be eligible to contribute to a qualified plan. As of January 2021, plan sponsors are required to track part-time employees’ hours to ensure all eligibility requirements are met. (2)
A good way to avoid this mistake is to consult your plan documents when making decisions about employee eligibility, especially as it relates to different types of plan contributions. For instance, long-term part-time employees are generally only eligible for participant deferrals, but not employer contributions. (3) Be sure to take these requirements into consideration when determining eligibility.
2. Not Following the Plan Document Compensation Definitions
Another common mistake comes from misinterpreting the compensation definitions, which in turn can cause mistakes in how much (or how little) is allowed to be contributed by the employer or the employee. For instance, in reading the plan documents, you may find that eligible employees are allowed to defer up to 10% of their compensation annually. But what does compensation mean in this instance? Does it include bonuses? Stipends? Overtime? Commissions? Most commonly, compensation consists of three types of income:
- Wages and salaries
- Payments for professional services
- Payments for personal services (tips, commissions, fringe benefits, etc.)
Put simply, you cannot rely on what you think the word “compensation” means. Instead, you must thoroughly review and understand your plan’s definition of compensation as well as what type of compensation each employee receives.
3. Not Maintaining Proper Plan Documentation
Retirement plan sponsors are required by law to keep extensive books and records both for the IRS and EBSA. Maintaining proper documentation will not only keep you prepared in case of an audit, but it will also help you avoid mistakes in other areas of plan administration. For example, proper documentation can help you make the right decisions about employee eligibility because you have the records to back up their hours and employment status, or understand the correct definition of compensation because your plan documents are clear-cut and properly maintained.
Plan documentation usually starts out very organized because it has to be in order for the retirement plan to be qualified and approved by the government in the first place. Over time, however, it can be hard to maintain, especially if there are a lot of participants or if there are changes to the structure of the plan. Avoid this pitfall by prioritizing proper documentation and ongoing organization, periodically reviewing when you can.
4. Not Having an Investment Plan Policy
The goal of a retirement plan is to help participants save for retirement through investments. Plan sponsors have a significant responsibility to work with an advisor to select appropriate investments, replace poor performers, and verify that the fees are reasonable. It’s critical to create and follow an Investment Policy Statement (IPS) to keep your plan’s investments up to date and within DOL guidelines. While an IPS is not legally required for retirement plans, most qualified retirement plan advisors agree it is essential.
Revising the IPS periodically is important to ensure it keeps compliance with changing laws. Also be sure that the IPS aligns with your plan’s documentation and does not conflict in any way. A well-structured, well-followed IPS does more harm than good if it conflicts with the plan document.
Are You Making Some of These Mistakes?
Don’t let the IRS or DOL find your plan noncompliant! At Farrall Wealth, we are here to help plan sponsors navigate their responsibilities with confidence. If you would like guidance on how to avoid or correct any of these mistakes, click here to get started today and don’t forget to check out the second part of this guide that will be posted next week!
Greg Farrall is CEO and owner of Farrall Wealth, an independent, boutique wealth management firm that is dedicated to helping women and business owners create customized financial plans that allow them to grow, protect, preserve, and distribute their wealth. Greg is known for being a problem-solver who walks his clients through whatever life throws at them. He prioritizes building long-term relationships and is passionate about going the extra mile for his clients so they can pursue their goals and live the lives they want. Greg has a bachelor’s degree in international business from the University of Wollongong in Australia and a bachelor’s degree in finance and marketing from Indiana University Bloomington. He is a Professional Plan Consultant® (PPC®) and a Certified Wealth Strategist® (CWS®) professional. And he recently received his Certified Plan Fiduciary Advisor (CPFA®) designation. You can listen to him on his financial literacy and business topic podcast, Money Matters with Greg, on iTunes, Google and Spotify. He’s also on YouTube, Twitter, and Facebook at @FarrallWealth.
Greg is a pillar of his community and served as the 2013-14 co-chair for the United Way campaign, through which he helped raise $1.8 million for 38 nonprofit organizations across Porter County, Indiana. He also served as president of the Valparaiso Rotary Club. Currently, he is on the advisory board for the Kelley School of Business and Dean of Students’ board at Indiana University. He also holds a position on the Culver Academies parents’ board.
When he is not working, you can find Greg spending time with his family or investing in one of his many passions, which include cooking, Spartan races, fly fishing, and meditation. To learn more about Greg, connect with him on LinkedIn.
Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
This information was developed as a general guide to educate plan sponsors, but it is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.