AVOID MISTAKES WITH TIMELY DEPOSITS

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2 EMPLOYEE BENEFITS INSIDER Spring 12 AVOID MISTAKES WITH TIMELY DEPOSITS In any qualified retirement plan, money comes in and money goes out. An area that garners Department of Labor (DOL) attention is what s known as timely deposits. The DOL actively enforces timely deposits of elective deferral contributions. To avoid problems, here s what you need to know. WHAT ARE THE REQUIREMENTS? Generally, plans appoint a fiduciary, typically the trustee, to ensure that all contributions (employee deferrals only, employer contributions to the plan have different criteria to be considered timely) are deposited into the plan in a timely manner. Larger retirement plans those with 100 or more participants must deposit employee contributions as soon as administratively feasible, but no later than the 15 th business day of the following month. In this day and age, administratively feasible is generally interpreted to be five business days or less by the DOL. The DOL gives smaller retirement plans (those plans consisting of fewer than 100 participants as of the beginning of the year) a safe harbor in which to make timely deposits, although the same rule applies to both large and small plans. Under the DOL s safe harbor, small plans must make deposits no later than the seventh business day following the date in which the amounts would have been paid to an employee as compensation. WHAT ARE THE CONSEQUENCES? If you fail to make timely employee elective deferral contributions, you ll be considered to have engaged in prohibited use of plan assets, otherwise known as a prohibited transaction. The initial excise tax on a prohibited transaction is 15% of the amount involved for each year in the taxable period. If you don t correct the transaction within the taxable period, the DOL will impose an additional tax equal to 100% of the amount involved. WHAT SHOULD EMPLOYERS DO? Employers should perform self-audits to make sure their plan complies with DOL regulations. Regularly review your plan document provisions on timely deposits of elective deferrals. Then, work with your payroll provider to compare the earliest date that you can segregate elective deferrals from assets to the actual deposit dates. This can help determine if you re depositing the contributions timely. HOW CAN YOU CORRECT A MISTAKE? Employers can make corrections and avoid excise taxes using the DOL s Voluntary Fiduciary Correction Program (VFCP). Under the program, you must restore the principal amount to the plan, plus the greater of: Lost earnings, from the date of the loss to the recovery date, or Profits resulting from the use of the principal amount from the date of the loss to the date the profit is realized. You must pay all expenses associated with correcting transactions, such as fees associated with recalculating participant account balances. Finally, you must make any additional distributions if necessary to former employees, beneficiaries or alternate payees. The DOL has a calculator available on its website to assist with the lost earnings calculation. HOW TO AVOID THE MISTAKE If you have personnel changes, make sure the new staff members have a full understanding of how and when to make deposits into a qualified retirement plan. Making timely deposits will not only avoid taxes and penalties, but it could also save the plan from potential disqualification. IF YOU FAIL TO MAKE TIMELY EMPLOYEE ELECTIVE DEFERRAL CONTRIBUTIONS, YOU LL BE CONSIDERED TO HAVE ENGAGED IN PROHIBITED USE OF PLAN ASSETS, OTHERWISE KNOWN AS A PROHIBITED TRANSACTION.

3 FEE DISCLOSURE RULES The Department of Labor (DOL) has issued regulations that require specific disclosure by companies providing services to qualified plans. The regulations go into effect July 1, 2012 (after several deferrals in the effective date). Plans affected include defined contribution plans, defined benefit plans and ERISA 403(b) arrangements. The regulations don t apply to Section 457 government plans, nonelecting church plans, Simplified Employee Pension plans, SIMPLE IRAs, IRAs and non-erisa 403(b)s. The regulations also currently don t cover welfare plans. Service providers not in compliance will be subject to prohibited transactions rules and IRS penalties. As a plan sponsor, two questions that likely come to mind are: Who is responsible for ensuring compliance and what do the regulations mean for you? A FEW DEFINITIONS The regulations purpose is to give plan sponsors a clear understanding of the fees associated with their plan so they can make informed decisions. Generally, a plan sponsor is the plan fiduciary and has the authority to bind the plan through contracts with service providers. A covered service provider is a vendor to the plan, such as an attorney, actuary or investment advisor. The provider must disclose fees if it enters into a contract and expects to receive $1,000 or more in compensation directly or indirectly from the plan. This can include record keeping services related to plan administration, such as retirement plan calculations, discrimination, and distribution and loan processing. Compensation includes remuneration for monetary value during the contract term of $250 or more. Compensation can be direct or indirect, and there are specific qualifications for each of these areas. Service providers receive direct compensation from the plan in the form of fees, commissions and directly related investment expenses. Providers receive indirect compensation from any source other than the plan, plan sponsor or service provider. This may include miscellaneous advisor and investment fees or fees paid directly to the service provider from one of their own vendors. Compensation may be expressed in monetary terms, a formula, a percentage of plan assets or a per capita charge for each participant. The provider must issue a description of the estimate that contains sufficient information, and the estimate must be reasonable. REQUIRED DISCLOSURES As a result of the regulations, covered service providers must disclose certain information to plan fiduciaries in writing. This includes a description of services provided to the plan under any contract or arrangement, including the provider s expected compensation. Covered service providers must also disclose: Any compensation that will be charged directly against a participant s investment, Annual operating expenses, and Ongoing operating expenses, such as wrap fees and expense fees. Providers must disclose these amounts reasonably in advance of the date the arrangement is entered into, extended or renewed, but no later than 30 days from the date on which the covered service provider enters the contract. And they must disclose changes as soon as practicable, not later than 60 days from the date the provider knows of the changes. THE NEXT STEPS It s up to plan sponsors to ensure they re receiving these new required disclosures from contract service providers. Thus, review your service providers material, as you may need to amend existing contracts to define the service providers disclosure obligations and any liability for failure to provide the required disclosures. It s helpful to have a system to review your service providers arrangements to ensure the contract furnishes the required disclosures in sufficient detail so that you can determine the reasonableness of the providers compensation. If one of your service providers fails to comply with the disclosure requirements, you must notify the provider and the DOL. SEEKING ADVICE Seek the advice of a seasoned retirement benefits advisor to determine if your service providers fees and other disclosures meet your understanding and expectations. Proper planning can help you meet your fiduciary responsibilities.

4 EMPLOYEE BENEFITS INSIDER Spring 12 THE ABCs OF ADP TESTING Most any employee benefit plan sponsor has seen the term actual deferral percentage (ADP). But what exactly does it mean, and how does it affect your plan? It s a test that all plan sponsors need to be aware of. In fact, the IRS requires qualified retirement plans to comply with ADP requirements with consequences for failure to do so. CALCULATING ADP The ADP nondiscrimination test compares the average salary deferral percentages for highly compensated employees (HCEs) to the average salary deferral percentages for non highly compensated employees (NHCEs) within a plan. For 2011, an HCE is an employee with more than $110,000 in 2010 compensation or an employee who owned more than 5% of the business during 2010 or The test ensures that the percentage deferred by HCEs in comparison with that deferred by NHCEs is within the IRS limits. The IRS includes both pretax elective deferrals and designated Roth contributions in the ADP test. But the regulations exclude catch-up contributions. The test also includes anyone eligible to participate in the plan whether or not they defer and regardless of whether they re active or terminated. You calculate the ADP for each person by dividing their total annual deferral amount into their annual compensation for the plan year. (An eligible participant who elects not to participate has an ADP of zero.) Then you determine the average for the HCEs as a group and the NHCEs as a group. PASSING THE TEST To pass ADP testing, the general rule is that the HCE average cannot exceed the NHCE average by more than 2%. But the Internal Revenue Code (IRC) specifically states that the HCEs ADP must not exceed the greater of: 1.25 times the ADP for NHCEs, or The lesser of two times the ADP for NHCEs or the ADP for NHCEs plus two percentage points. Unless the plan document specifically states otherwise, the IRC allows plans to measure the HCEs current year deferrals against the prior year s NHCE deferrals. This approach, called the prior year testing method, helps minimize the potential for a failed test because the HCEs know what their ADP limit is for the current plan year.

5 If the plan document states that you must use the current year testing method, you can perform a projected ADP test midyear to help estimate the current year ADP limit. This estimate allows HCEs to adjust their deferral percentages in an effort to pass testing. CORRECTING MISTAKES Plan sponsors must correct a failed ADP test by March 15 th of the year following the plan year for calendar year plans or within two and a half months after the close of the plan year for fiscal year plans. If the sponsor chooses to deposit a qualified nonelective contribution (QNEC), they have the statutory correction period to make the deposit (by no later than December 31, 2011, for a failed 2010 test). To bring the plan into compliance, the IRC provides two correction methods for a failed ADP test: 1. Distribute excess contributions to HCEs. Doing so will bring down their average salary deferral percentages enough to pass. The return of excess contributions to the HCEs is a taxable distribution to the individual in the distribution year. If an HCE is over age 50, some or all of the regular contributions may be reclassified as catch-up contributions, lowering the amount to be refunded. If you use this method, you must do so by March 15 th of the year following the plan year. If not, the plan sponsor must pay a 10% excise tax on the total amount of excess contributions. 2. Contribute a QNEC to some or all NHCEs. This is immediately 100% vested and brings up the NHCE average salary deferral percentage enough to allow the HCEs to keep their deferrals in the plan. You must deposit the QNEC no later than Dec. 31 of the year following the close of the plan year in which the mistake occurred. The plan administrator will determine the best method of correction depending on individual circumstances for each plan and employer. The method of correction doesn t have to be the same each plan year of failure. KNOWING YOUR EMPLOYEES Educating employees about the benefits of retirement saving can help encourage more plan participation and help those already participating to increase their deferral contributions. This, in turn, can help your plan pass future ADP testing.

6 RANDY DUMMER, CPA Randy Dummer, CPA, joined Henderson Hutcherson & McCullough, PLLC, as a Member in Formerly with Baker Tilly Virchow Krause, LLP, in Appleton, Wisconsin, Randy led the employee benefit plan audit practice of 700 engagements, training 200 team members in nine offices. With over twenty years of experience, Randy has already proven to be a huge asset to HHM s Audit Practice. A discussion leader for the American Institute of Certified Public Accountants, Randy has taught seminars across the country to other CPAs on accounting and audit topics including courses on employee benefit plan audits, accounting and audit updates, compilations and reviews, and services to automobile dealerships. He was recently awarded the Outstanding Discussion Leader Award by the AICPA for the 4th consecutive year. Randy received a Bachelor of Science in Accountancy from the University of Wisconsin LaCrosse, graduating with highest honors. If you have questions for Randy or would like additional information about how HHM can help your company or organization, please rdummer@hhmcpas.com or call CALL THE EMPLOYEE BENEFITS SPECIALISTS AT HENDERSON HUTCHERSON & MCCULLOUGH, PLLC E. LADELL MCCULLOUGH, CPA LADELL@HHMCPAS.COM RANDY M. DUMMER, CPA RDUMMER@HHMCPAS.COM FREIGHT DEPOT 1200 MARKET STREET CHATTANOOGA, TN HHMCPAS.COM