As the time approaches to complete your annual data collection, you may be asked if any deposits to the plan were not made in a timely manner.
Money withheld from a participant’s paycheck as pre-tax deferrals, Roth deferrals or loan repayments must be contributed to the 401(k) or 403(b) plan within the time frame specified by the Department of Labor (DOL). Although the exact requirements can vary depending on the plan, deposits must be made as soon as it is administratively feasible to do so.
What does “as soon as administratively feasible” mean? Essentially, this is the earliest date the money can be separated from company assets. Once you can access the withholdings, they should be deposited. Often, this is the actual pay date. While this is the go-to rule in most cases, smaller plans that start the year with fewer than 100 participants can take advantage of a safe harbor provision in which deposits can be considered timely so long as they are made within 7 business days of withholding. The best practice is to deposit your employees’ deferrals and loan repayments as soon as possible and to be consistent about what that entails. For example, if your processes and procedures allow the deposit to be made on the Monday following a Friday pay date, be sure to follow these same processes every pay period.
Do these late deposit rules also apply to employer contributions? No, employer contributions have different deposit rules. Check with your accountant for tax deduction timing.
Why is this important? Once the money is withheld from a participant’s pay, it becomes a plan asset. The plan exists for the exclusive benefit of the plan participants. When the money stays in the company’s account, it benefits the company instead of benefiting the participants. This is a prohibited transaction because it violates the exclusive benefit rule.
Should I deposit deferrals before the pay date? No, the deferrals and loan payments don’t become plan assets until being withheld from the employee’s paycheck. If the money is contributed to the plan prior to the pay date, the contribution is considered an employer contribution rather than an employee contribution. In addition, the employee contribution will need to be funded in a timely manner. An exception can be made when the individual who usually makes the deposit will be out of the office when the deposit is scheduled, but the situation should be well-documented in case questions arise in the future.
How do I prevent late deposits? The best way to prevent late deposits is to establish procedures and follow them. This should include comparing the amount withheld from payroll to the amount remitted to the plan, as sometimes participants are accidentally left off the contribution upload. In these cases, a simple reconciliation to payroll will prevent a late deposit. If you find you lack the necessary staff to consistently make deposits to the plan, it may be worthwhile to consider services provided by your accountant or payroll company which could handle this on your behalf.
What happens if I make a late payment? The participants will need to be made whole, as if the deposit was never late. The plan sponsor will need to compensate the appropriate participant account(s) with the lost earnings; and for 401(k) plans, a 15% excise tax on the lost earnings will need to be paid. In addition, the late deposits are listed on the Form 5500 and could trigger an audit. There is no minimum limit here, so even if the correction and excise tax are small amounts, the correction still needs to be made.
In summary, even when the correction itself is minor, the effects of a late deposit can be enormous. To avoid the possibility of repercussions, consider your current processes for making deposits to the plan and determine if any adjustments are needed to ensure that your deposits are timely.
