Taking too long to deposit an employee’s salary deferral contributions into a 401(k) plan is a big no-no. We hear all kinds of excuses why plan sponsors take too long to make their deposits. Reasonable as they may sound to the person making them, the excuses rarely hold any water with the Department of Labor.
Deposit Deadline Is Effectively “ASAP”
According to DOL regulations, participant contributions usually become plan assets on the earliest date the contributions can reasonably be segregated from the employer's general assets. It is a prohibited transaction for plan assets to be commingled with company assets. Prohibited transactions are subject to excise taxes. The employer will want to deposit the contributions before a prohibited transaction occurs. Holding plan assets in a company account is also a fiduciary violation.
The general deadline for depositing participant contributions is “as soon as you are able to do it.” If you can deposit the contributions within four business days, then four business days is your deadline. If you can make the deposit within two business days, then two business days is your deadline. If you make the deposit for the February 1 pay period two business days after the pay date, but you take four business days to make the February 15 deposit, the February 15 deposit might be considered two days late because you showed with the February 1 deposit that you are able to make the deposit within two business days.
There is an exception for small plans (fewer than 100 participants). Small plans get at least seven business days to make their deposits. Even if they can do the deposit in two business days, small plans still get at least seven business days. If for some reason 10 business days are needed to make deposits to a small plan, then 10 business days is the deadline, not seven business days. The seven-business day rule is a safe harbor. A small plan always gets at least that much time, but can have more if needed.
The absolute deadline for depositing salary deferrals is the 15th business day of the month following the month the deposits were withheld from the paycheck. For a March 3 paycheck as well as a March 31 paycheck, the absolute deposit deadline is the 15th business day of April. Some have misinterpreted this rule and think they always have until the 15th business day of the next month to make their deposits. Not so. It is very rare that a company should need that long to make its deposits. The true deadline will almost always occur much earlier. Anyone needing longer than the 15th business day of the next month should review its procedures and take steps to ensure that deposits can be made much sooner.
In plans that provide for individual investment direction, contributions do not need to be allocated to the individually directed accounts to meet the above deadlines. Rather, the contributions just need to be in some account that is part of the plan’s trust, such as a checking or money market account. The contributions can be moved to the individual accounts later.
Most of the same rules about when to deposit 401(k) contributions also apply to participant loan repayments.
Late Contributions Were Made. Now What?
Sometimes, despite its best efforts (or not), an employer may find that it is late in depositing participant 401(k) contributions. What then? There are two things we know for sure. In an obvious first step, the contributions should be deposited immediately if this has not happened already. Second, the participant will need to be given investment earnings on those late contributions reflecting the period of time the contributions were not in the plan but should have been.
After that, there are some administrative steps and other corrective actions that need to be taken. For starters, there is a question on the Form 5500 series asking whether there were any late contributions. This needs to be answered yes.
From there, there are a couple of choices. For the prohibited transaction, the employer could file Form 5330 and pay a 15 percent excise tax on the amount involved. There is an example in IRS Revenue Ruling 2006-38 where $100,000 in deferrals were deposited about a year late, resulting in an excise tax of $844. Your results will vary.
If filing an IRS form and paying an excise tax is not an appealing option, the employer may wish to avail itself of the DOL’s Voluntary Fiduciary Correction Program (VFCP). If certain conditions are met, including the deposit being not more than 180 days late, the employer will not have to file Form 5330 and pay an excise tax if it uses VFCP. Under VFCP, the employer has to file with the DOL and deposit lost earnings into the plan using specific methodology. There is an example in VFCP of a $10,000 contribution made about a month late that resulted in lost earnings of $65.69 owed to the plan. Because these earnings weren’t deposited for several years after they were due, $11.64 in interest was owed on the lost earnings. That is, they had to pay interest on interest.
An employer making late contributions doesn’t have to fix the mistake using VFCP. The “V” in VFCP stands for “voluntary” (despite what the DOL may try to imply). The employer can fix the problem some other way. Although VFCP tells you exactly how to compute the lost earnings and even provides an online calculator to do so, the calculation is a bit of a hassle, particularly for small amounts. Suppose a $100 salary deferral is two months late. Rather than pay a professional a bunch of money to calculate an exact lost earnings amount that might end up being a few dollars, an employer might ask if it can just provide, say, $10 of lost earnings and be done with it? That is permissible; however, the employer will not be in compliance with VFCP, so the Form 5330 will have to be filed and excise tax paid.
The rules about fixing delinquent contributions are hard. If you are faced with a late contribution or loan repayment in real life, you will need to look into the correction steps further, as this overview does not cover every situation.
Suffice it to say, depositing 401(k) salary deferrals late is bad. You’ll have to make up the missed contribution with earnings and maybe pay an excise tax. It’s just a big headache. Know the deadlines and figure out a way not to be late.