Timely Elective Deferral Contributions - A Guide To Getting It Right

Since you offer a 401(k) to your employees, you know there are a lot of steps involved with plan compliance to get it right. And one of the biggest things you need to make sure you do is deposit employee contributions on time. Since elective deferral rules and requirements can be confusing, we’re going to break them down for you here.

In this article, we’ll explain how deferrals work, when they’re due, what happens if they’re late, and how to prevent problems before they occur. After reading this, you’ll know the best approach to ensure compliant 401(k) elective contribution practices at your company.

What is an elective deferral?

An elective deferral is the amount an employee elects to contribute to their 401(k) from their salary, which you as the employer then contribute to their retirement account on their behalf. Depending on how you’ve set up your plan, employees can choose to make these deferrals on a pre-tax basis for a traditional 401(k) or after-tax basis for a Roth up to an annual maximum set by the IRS. For 2023, the maximum elective deferral amount for an individual is $22,500 with an extra $7,500 allowed as a catch-up contribution for those 50 and over.

How do elective deferral contributions work?

When an employee enrolls in your 401(k) plan, they’ll complete an elective deferral agreement that indicates the amount they want withheld from their compensation. (Employees can change the amount by completing and signing a new agreement.) Each pay period, you’ll withhold the amount the employee authorized from their paycheck and transfer it into their retirement account, where it will be invested according to the employee’s preferences.

When are elective deferral contributions due?

For small plans with less than 100 participants, the safe harbor standard states that any deposits made within 7 business days of a pay date are considered timely under the Department of Labor (DOL) rules.

Unlike small plans, large plans do not have a precise deadline. Your plan documents may or may not provide a specific time for deposits. If not, employers must deposit elective deferral contributions into the plan as soon as reasonably possible, but no later than the 15^th business day of the following month the amounts were withheld from the employee’s pay under the DOL rules. It’s important to note that does not mean you can wait until the 15^th business day of the following month as a failsafe; if you consistently deposit employee contributions within 10 business days following a pay date, you must continue to do so in that manner or the contributions will be considered untimely.

What happens if contributions are late?

There are a few significant consequences if you don’t deposit employee deferrals on time. First, if you don’t make deposits in a timely manner (depending on the scenario), it may constitute an operational mistake, which can lead to plan disqualification. It is also considered a prohibited transaction.

The second serious result of a late transfer of employee elective deferrals is that you may have to pay a 15% excise tax if the delay is a prohibited transaction. You’ll use Form 5330 to pay the tax. In addition, if a DOL audit finds an uncorrected prohibited transaction, it may impose an extra 20% penalty on the amount of the late deposit.

Lastly, you’ll need to note on the annual Form 5500 that you didn’t make all deposits of elective deferrals on time.

How can I correct a late deferral contribution?            

You can correct an operational mistake under the IRS’ EPCRS to avoid plan disqualification. While a prohibited transaction can’t be corrected under EPCRS, the DOL has a Voluntary Fiduciary Correction Program that can be used. We’ll discuss both approaches here.

DOL

The DOL’s Voluntary Fiduciary Correction Program can be used to correct the error before the DOL’s Employee Benefits Security Administration has begun an audit of the plan. To start the process, you should deposit the deferrals immediately and make an additional contribution to cover the lost investment gains. The DOL provides an online calculator to determine the amount of missed earnings. You’ll also need to prepare a written submission with proof of payment of earnings on late deposited elective deferrals and loan repayments and provide supporting documentation. After successful submission, you’ll receive a “no action” letter that can demonstrate plan compliance.

While you can usually fix the mistake under the DOL’s Voluntary Fiduciary Correction Program, you may need to correct it through one of the IRS programs if the terms of your plan weren’t followed.

IRS

If your plan specifies a time for deposits, and you don’t meet them, you may have an operational mistake requiring correction under the IRS’ EPCRS. There are 3 programs available:

1. Self-correction Program: This allows you to correct insignificant failures without contacting the IRS or paying a fee. It’s important to note that the DOL has not issued guidance to allow for self-correction for late deposits.
2. Voluntary Correction Program: The program allows you to pay a fee and receive IRS approval for correcting the mistake before an audit.
3. Audit Closing Agreement Program: With this option, you’ll pay a sanction and be permitted to fix the error while your plan is under audit.

How can I prevent late contributions in the future?

To minimize the likelihood of a delay, your company should have a process in place for depositing deferrals on a schedule that coincides with each payroll based on the earliest date you can reasonably make deposits. Be sure to train new staff on when deposits must be made.

If you work with a payroll provider, leverage your vendor to establish a date for deferrals and make sure it matches your plan document provisions, if applicable. Part of your partner’s service should be ensuring submission of withheld amounts by the deposit deadline. You’ll also want to ask about automated 401(k) payroll integration, which can not only reduce your team’s administrative burdens but also ensure greater accuracy and compliance with the deferral deposit requirements.

Ensure Timely Elective Deferral Contributions

Since there’s a lot riding on timely elective deferral contributions, it’s critical to get them right. That’s why a lot of companies choose to partner with a 401(k) provider to handle all the responsibilities involved with managing a plan, including elective deferral deposits.

As you evaluate your options, you may wonder what 401(k) services Complete Payroll Solutions offers you and your employees. Read about CPS' retirement plan administration and full-service retirement plan services to see if we may be the right partner for you.