Compensation Errors in Benefit Plans
How to Find, Fix and Prevent Them
As a firm we audit close to 200 employee benefit plans each year, including a mix of defined contribution, defined benefit, ESOP, and health and welfare plans. The plans that we work with are typically extremely well-run by sponsors and administrators who are very focused on meeting their fiduciary duties to the plan participants. However, plan documents can be complex, and despite the fiduciary’s best effort, “things” happen. There can also be times when there is confusion regarding who is doing what and sometimes plan administrators believe their third party providers are doing a lot more than they really are.
Last year, we spent some time reviewing the most common issues we encounter on a day-to-day basis. Really, a dirty dozen list of sorts. This year, we are going to dig into the details of a few specific examples that we have encountered over the years. More importantly, we are going to spend some time explaining the steps that were taken to fix the problem as well as explaining steps you can use to avoid the problem in the first place!
Why is this important?
There is serious responsibility that comes with serving an employee benefit plan in an oversight role and this responsibility is often minimized or overlooked. I don’t know an auditor who hasn’t heard a plan administrator (someone at the company sponsoring the plan) say “We pay our TPA to do that, you will have to ask them.” I cringe every time. The Department of Labor has made it perfectly clear that the buck stops with the plan administrator (including cases where they have held individuals personally responsible in order to make a plan whole).
The following are some specific cases we have seen and the steps that were taken to resolve the problem. You will notice a common theme in that these cases revolve around the proper application of compensation per the plan document, and in most cases improperly excluding amounts from compensation for the purposes of calculating employee deferrals or employer match amounts. We chose to make this our focus because it is definitely towards the top of the “dirty dozen” list, it can take many forms, and can at times require costly corrections.
Plan restatement or amendments
A plan had always specifically excluded bonuses from plan compensation. It had been several years and many amendments since they had last restated their plan document so they did what a good fiduciary would, and had the attorneys get everything cleaned up. Mind you, the intention was to simply incorporate all of the amendments, and they had zero intention of changing a single thing related to how the plan actually operated.
As we read through the new plan document during our audit we noticed something interesting: The section that excluded bonuses from eligible compensation was not there. The plan had kept operating as it always had but now the sponsor found itself out of compliance with the plan document.
Working with the TPA and ERISA attorneys it was determined that in this case it would be appropriate to classify the mistake as a “scrivener’s error,” which is essentially a typo when drafting the plan document. It is important to note that there was a very clear case to make this argument including a long string of emails, revisions of the plan document, and the historical operation of the plan which indicated that the company had no intention of changing its treatment of bonuses.
There have also been multiple times where we have talked about a new plan amendment with plan management only to learn that the actual document is different. We highly recommend reading through any new amendments, restated plan documents, or adoption agreements to ensure that what you think is being said is what is actually being recorded. This is the single easiest way to prevent these types of problems from occurring.
Overreliance on a service provider
A very typical arrangement is for employers to use a payroll company to help calculate employee deferrals and employer match amounts as part of the regular payroll processing. Essentially, the process is that the employer indicates which classes of wages are considered eligible compensation and the provider programs the system to calculate the deferrals and match accordingly. At some companies, the number of class codes (pay codes) can be fairly extensive with various fringe benefits, on-call rates, shift differentials, etc.
Several years ago one of the widely used payroll providers changed its processing platform. This wasn’t a problem for almost all of our clients. However, for one employer, several of the programed selections changed regarding whether a pay code was eligible compensation or not. The result was that the plan wasn’t operating in accordance with the operating agreement.
In this case the error was definitely not a typo. The correction made was typical (and required) – the employer made the employees whole by remitting the missed employer match and 50% of the missed employee deferral, plus earnings. Obviously, when you are aware of changes like this at your payroll provider or TPA, it is extremely important to review the first few post-conversion payroll runs. Also see our think like an auditor section later in the article.
Imputed income and non-typical wages
Many plans define compensation as all wages reported on an employee’s Form W-2. Keep in mind that noncash compensation, such as group term life insurance, can also qualify as taxable wages on Form W-2. These become difficult to track in that the expenses are typically paid directly by the employer on behalf of the employee.
So now we get to the part that doesn’t make much sense logically. Our plan document says that W-2 wages are compensation and we know that an employee has elected to defer a certain percentage from their wages. So we have to defer from wages that weren’t directly paid?
The answer is “yes.” One solution to this would be to amend the plan document to specifically exclude these types of wages. Another would be to work with your service providers to ensure the proper deferrals and matches are made.
Deferrals and match amounts on special payroll runs can also cause problems. Examples include cash or gift cards for a special employee recognition event, vacation cash out payments, bonus runs, or really anything which is outside of the regular payroll cycle. Just keep in mind that your plan document is the final word, and if it says those amounts are included, they need to be included. We have also seen instances with the gift card example where the deferrals and matches weren’t being made since the payments weren’t included in the employee’s W2s in the first place. Hint—the IRS probably isn’t going to like that answer.
Think like an auditor
We found every single one of these errors during our audits using the exact same procedures each time and there is nothing preventing you from doing it yourself. Obviously catching a mistake up front is preferable and this provides a great double check if done on a regular basis.
The first step is to read the plan document and understand what the definition of compensation is for your plan. This is extremely important because as we noted before, there often is a disconnect between what people think the plan document says and what it actually does say. Next, pick a handful of employees and pull out their deferral elections for the year. Then, multiply eligible wages by the elected deferral rate. Finally, compare your answer to what the payroll register says was actually withheld. If there is a difference, then you may have a problem. Follow this step up by doing the same thing with the match formula.
For additional information, please contact Matt Prunier or your BNN advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.