The Department of Labor
(DOL) has finally provided much anticipated guidance for the timely
deposit of elective deferrals in qualified 401(k) plans. The
proposed regulation keeps the same basic framework for determining
if contributions are timely deposited but adds a safe harbor rule
that many plans can utilize.
This newsletter will discuss the new rules, as well as the timing
requirements for other types of plan contributions.
401(k) Salary Deferrals
A large percentage of retirement plans today are funded by
employees' own contributions. In a 401(k) plan, participants can
elect to defer a portion of their salary which is withheld from each
paycheck. Deferrals can also be made from bonuses or other special
compensation awards, if the plan allows.
The question arises as to how quickly the employer must transmit
such deferrals to the plan once they have been withheld.
Existing Deferral Deposit Rules
Until now, DOL regulations provided only that salary deferrals
must be deposited as soon as they become plan assets and that occurs
as of the earliest date such contributions can reasonably be
segregated from the employer's general assets. The DOL did not
provide any more specific instructions on how this date could be
The regulations also state that in no event shall the segregation
date be later than the 15th business day of the month following the
month the contribution was withheld. But the DOL has stated
emphatically that this was not to be relied on as a safe harbor date
and that most employers should be able to segregate the funds much
sooner than the outside limit.
Upon audit, many employers were penalized for late deposits based
on the enforcement of these regulations in a highly subjective
manner. That's because the rules did not adequately provide
objective standards that could be fairly applied to every situation.
For many years there has been no definitive standard for determining
if deferrals were being deposited on a timely basis in the opinion
of the DOL.
When deferrals are not deposited on a timely basis, the employer
is considered to be commingling plan funds with its own funds. The
employer becomes liable for the payment of lost earnings to
participants' accounts as well as prohibited transaction penalties.
Trustees may also be liable for fiduciary breach penalties.
New Safe Harbor for Small Plans
On February 29, 2008 the DOL issued proposed regulations
providing additional guidance on this issue. The existing standard
of making deposits as soon as the money can be segregated from the
employer's general assets remains in force. But a clear safe harbor
time frame is established for small plans with fewer than 100
participants at the beginning of the plan year. The safe harbor
deadline is the 7th business day after the day on which such amounts
would have been payable to the participant in cash (in other words,
withheld from paychecks).
The 100 participant cut-off for small plan status under the safe
harbor deposit rule is not the same as small plan filing status of
Form 5500. That is, a plan with a participant count between 100 and
120 may be able to file Form 5500 as a small plan but cannot utilize
the 7-day safe harbor deposit rule. Plans with 100 or more
participants at the beginning of the plan year are subject to the
existing deposit rules.
Loans to plan participants, secured by their vested benefits, are
common in 401(k) plans. Repayments are often deducted from the
employee's wages, similar to salary deferrals. The same 7-day safe
harbor deposit rules apply to loan repayments.
The new safe harbor rule will become effective on the date of
publication of final regulations in the Federal Register. But the
DOL has clearly stated that employers can rely on the proposed safe
harbor deadline until final regulations are issued. This provides
immediate relief for many employers who now have at least 7 business
days to make timely deposits without the uncertainty that previously
Small employers who feel that they can't reasonably segregate
withheld deferrals from their general assets within the 7-day period
may want to rely on the existing deposit rules and ignore the safe
harbor. But that may be a risky position to take now that a safe
harbor has been established.
In order to encourage employees to participate in their 401(k)
plans, employers will often provide a matching contribution. It is
usually based on the employee's elective deferrals or a portion of
such deferrals. Matching contributions are often deposited
throughout the year along with deferral contributions.
The actual deadline for making matching contributions that are to
be allocated for a particular year and included in the
nondiscrimination test is the last day of the following plan year.
But in order to be deducted on the employer's tax return for the
year allocated, the contribution must be deposited by the tax return
due date, including extensions. Different deduction rules apply
where the employer's fiscal year is different than the plan year.
Example: ABC Company's fiscal
and 401(k) plan year are both the calendar year. The company always
deposits the entire matching contribution after the plan year end.
For 2007, ABC filed for an extension (to September 15, 2008) to file
its federal tax return. The matching contribution is made September
12, 2008. Since it was contributed before the federal tax return due
date (including extension), it is deductible on the 2007 return.
QNECs and QMACs
Each year a separate nondiscrimination test must be performed for
salary deferrals (ADP test) and matching and/or voluntary after-tax
contributions (ACP test) under a 401(k) plan. One method of passing
an otherwise failed test is for the employer to make a qualified
nonelective contribution (QNEC) or a qualified matching contribution
(QMAC) to some or all of the non-highly compensated employees.
In order to be utilized in the test for a particular plan year,
these contributions must be made by the last day of the following
plan year. The timing issues that apply to the deduction of matching
contributions also apply to QNEC and QMAC contributions.
Safe Harbor 401(k) Contributions
A 401(k) plan will be treated as automatically passing the ADP
test for any year that it satisfies the safe harbor contribution
requirement and the notice requirement. The contribution requirement
can be met by either a specified matching contribution rate or an
employer nonelective contribution of 3% of eligible employees'
Generally, the safe harbor contribution must be made by the last
day of the following plan year. The timing issues that apply to the
deduction of matching contributions also apply to safe harbor
Where the safe harbor matching contribution is being made on a
per payroll basis instead of an annual compensation basis, the match
must be deposited by the last day of the following plan quarter.
Profit Sharing Plans
Employer nonelective contributions to a profit sharing plan are
generally credited in the year they are deposited. However,
contributions made after the end of the employer's fiscal year but
before the due date for filing its federal tax return (including
extensions) may be considered to have been paid as of the last day
of the fiscal year. If the employer's fiscal year is different than
the plan year, other factors may have to be considered.
Example: The XYZ Corporation's
fiscal year is the calendar year. XYZ's profit sharing plan also has
a calendar plan year. For 2007, the due date of XYZ's federal tax
return was extended to September 15, 2008. Any employer nonelective
contributions deposited by that date can be considered deposited on
December 31, 2007 and allocated under the plan as of that date. They
would be deductible to the corporation for 2007.
Money Purchase Pension Plans
Unlike profit sharing plans, in which employer contributions are
often discretionary, money purchase pension plans require a specific
contribution formula. Failure to deposit the required contribution
is a violation of the minimum funding standards. The contribution
deadline for minimum funding purposes is 8½ months after the end of
the plan year. If the deadline is not met, the employer is subject
to a late funding penalty.
Where the employer's fiscal year is the same as the plan year,
this date matches the day a corporation could extend the due date of
its tax return. This allows the employer to deduct the payments
necessary to fully fund the plan within the allowable funding
period. However, the 8½-month funding period exists regardless of
whether or not the corporation files for an extension.
Non-corporate entities such as partnerships and sole proprietors
have different tax filing due dates which must be taken into
consideration for deduction purposes.
Top Heavy Contributions
If a plan is considered to be top heavy (i.e., at least 60% of
the benefits belong to key employees), it must provide minimum
contributions, usually 3% of compensation, to non-key employees.
Though there is no clear deadline for top heavy contributions, it is
advisable to make such contributions by the employer's deduction
Defined Benefit Pension Plans
The funding requirements for defined benefit pension plans are
based on actuarial calculations which spread out payments over the
years to provide for specific benefits as they become due.
As with money purchase plans, defined benefit plans are also
subject to the minimum funding rules which allow required
contributions to be made up to 8½ months after the end of the plan
year. Plans that do not contribute enough money to fully fund the
current benefit liabilities must make deposits on a quarterly basis
or else notify employees that quarterly deposits will not be made.
The timing issues that apply to the deduction of money purchase
plan contributions also apply to defined benefit plan contributions.
Earlier this year the DOL provided long-awaited relief from the
vague and confusing salary deferral deposit rules for small
employers. The new 7-day safe harbor is a reasonable deadline that
most small companies should be able to meet. If not, the existing
guidelines are still available. Failure to make timely deposits
could subject the plan to lost interest payments and penalties.
It is important that both employee and employer contributions be
deposited by the required due dates to keep the plan properly funded
and in compliance with qualification requirements.
[top of page]