Common 401(k) Plan Mistakes – Running the Plan Based on your Employee Handbook
Employee handbooks are great for communicating an employer’s basic policies and procedures. However, a retirement plan sponsor will always want to check the actual plan document to confirm proper plan operations. When it comes to retirement plans or benefits in general, an employee handbook will not get into some of the details, and this can cause issues, both minor hiccups and major problems.
Here are several situations I’ve encountered over the years in working with retirement plans.
A handbook said to cut off all benefits at employment termination. In this particular case, payroll interpreted that to say 401(k) should not be withheld and match should not be awarded on unused vacation pay for a terminated employee. Unfortunately, the plan document was not consulted – and in this case the plan didn’t distinguish between regular W-2 compensation and unused vacation pay for this purpose. As a result, a corrective contribution had to be made for the terminated individual. Compensation errors are among the most common employee benefit administration errors, and it pays to understand what the plan actually counts towards contribution-eligible compensation.
Sometimes a handbook’s benefit eligibility section is worded in terms of the way the employer’s health and welfare benefits program operates, and the reader assumes this means all benefits. For example, health benefits are often available after a short affiliation period, and it is assumed that the retirement plan is subject to the same waiting period. While larger employers likely have policies and procedures in place to ensure mistakes are not made in this area, smaller employers who have infrequent hires would do well to review the eligibility terms of the 401(k) or other retirement plan from time to time and develop similar procedures around the plan document provisions.
If your handbook says that part-time employees do not qualify for benefits, watch out! I once had several employees with hire dates from many years ago show up on a client’s annual census report for the first time ever. When I asked if they were rehires, I was told no, they are part-timers who “don’t qualify for benefits” – the employer just happened to add them to the file this year. The problem was that several of these employees had worked over 1,000 hours in a year in the past (an average of just 20 hours a week works out to over 1,000 annually). The IRS says that you must generally cover these folks, and that part- timers can’t be excluded from the plan as a class. Fortunately, in this case, the pays involved were not large and the dollar amount of the correction was manageable – but things could have been a lot worse. How can a plan sponsor avoid this mistake? First of all, make sure whatever data feed you give your TPA includes all of your employees. And secondly, make sure you understand your eligibility provisions so you don’t find out that you have to reinstate someone into the plan retroactively. At the very least, it will be a hassle. At most, there could be a significant financial impact on the employer.
While the impact is likely minimal, definitions of things like “retirement” and “disability” can vary from your manual to your plan document. It is not uncommon for your plan to define disability as qualifying for Social Security disability benefits, which may not match your long-term disability insurance policy definition. And note that if a plan defines “retirement” as age 65, or age 55 and 5 years of service, etc. a participant will be considered retired for plan purposes if he met these requirements, even in the event of an involuntary termination.
Your employee handbook is a good tool. However, don’t let a well drafted manual lull you into complacency when it comes to really understanding your retirement plan’s operations. Understanding your actual plan document can pay huge dividends in helping a plan sponsor avoid everything from relatively minor but confusing PR situations to corrections which involve significant financial impact. Know your handbook, but also know where it is not going to give you all of the details – and then make sure you understand your plan’s provisions to fill in the gaps.
Scott Gehman, ERPA, CEBS
Retirement Plan Consultant