When I meet with prospective clients, they typically view the administrative duties performed by a potential provider as a commodity, i.e. all providers are the same, when in reality this couldn’t be further from the truth.  The most significant liability faced by an employer who sponsors a retirement plan is related to the administrative duties performed internally or outsourced to a service provider (Third Party Administrator a.k.a. TPA).

An employer sponsored retirement plan, i.e. 401(k) plan, must comply with specific government defined guidelines to maintain the tax preferences given to them, e.g. tax deductibility and tax deferred accumulation. The Internal Revenue Service (IRS) and Department of Labor (DOL) are the primary governmental agencies that enforce these guidelines. Both have active audit programs that are designed to discover and correct compliance failures.  Retirement plans that are not in compliance may face significant penalties.

DOL inflation adjustment to increase penalties

The DOL recently made an inflation adjusted increase to the penalties it can impose on a retirement plan. These penalties, enforced by the DOL’s Employee Benefits Security Administration, are assessed for noncompliance with certain administrative requirements under the 1974 Employee Retirement Income Security Act (ERISA).

The 2015 Inflation Adjustment Act requires  government agencies to adjust penalties with an initial “catch-up” adjustment, factoring in inflation through October 2015. Following this initial adjustment, agencies will adjust for inflation on an annual basis. The DOL published its catch-up adjustments in the Federal Register on July 1, 2016. The catch-up adjustments apply to penalties assessed after August 1 of 2016, whose associated violations occurred after Nov. 2, 2015.  Starting in 2017, the DOL will adjust penalty amounts for inflation annually by January 15.

For example, failure to file an annual Form 5500 carries a maximum penalty of up to $2,063 per day, almost double the current penalty of up to $1,100 per day. The penalty for failure to furnish certain reports, such as pension benefit statements to former participants and beneficiaries, has increased to $28 per employee, compared to the previous $11 per employee.

Retirement plan penalties assessed by the IRS

The IRS also imposes penalties for failure to operate a retirement plan within the required guidelines.  For example, the IRS’s penalty for failure to file a Form 5500 is $25 per day up to a maximum of $15,000.  The penalties imposed by the IRS are separate from those of the DOL.  However, an employer may be subject to both IRS and DOL penalty assessments.

How to prevent penalties from the IRS and DOL

The first line of defense for an employer who sponsors a retirement plan is to do everything possible to avoid making administrative mistakes. In my experience, very few employers have the ability to administer a retirement plan in-house so this role should be outsourced to a TPA.  It is very important the employer understands the duties they cannot outsource and those that can be performed by the TPA.  This will minimize the possibility for administrative errors.  However, even plans that have strong governance programs make mistakes.

How to fix mistakes

Fortunately, mistakes that are discovered before a plan is audited by the DOL or IRS can be remedied using programs offered under the Employee Plans Compliance Resolution System (EPCRS), Delinquent Filer Voluntary Compliance Program (DFVCP)  or Voluntary Fiduciary Correction Program (VFCP). Employers should make sure the TPA they select has the expertise to identify problems proactively and use the appropriate government program so the employer can avoid civil and criminal penalties by voluntarily reporting and correcting violations.

Steve Shearn