When participant deferrals must be deposited to the 401(k) plan trust
Under Department of Labor (DOL) guidance, 401(k) plan deferrals must be deposited on the earliest date the funds can reasonably be separated from the employer’s general assets.
However, the deposit should never occur later than the 15th business day of the month following the withholding of the employee’s wages. For example, if the contribution is withheld for the June 15th pay period, the deposit should occur no later than the 15th business day in July.
While the word “reasonably” is not defined under federal law or guidance for purposes of determining whether a deposit of deferrals has been made timely, the DOL rules described above indicate that it is never reasonable for such a deposit to fail to be made by the 15th business day of the month following the withholding of the employee’s wages.
The safe harbor rule
The Department of Labor (DOL) regulation 29 CFR 2510.3-102 provides a seven (7) business day “safe harbor” rule for plans with fewer than 100 participants at the start of the plan year. Under the Safe Harbor rule, plans are considered to have made timely deposits of deferral contributions if they are placed in the plan trust within seven (7) business days from the date they are withheld from wages.
For plans with 100 or more participants, there is no safe harbor rule.
Who is responsible for depositing deferrals?
Under federal law, it is the plan sponsor's obligation to ensure that deposits are made timely, regardless of whether the plan has contracted with service providers to perform any duties related to administering the plan.
401(k) plan deferrals are not deposited to the trust in a timely manner
A plan sponsor’s failure to deposit funds in a timely manner may constitute a prohibited transaction under ERISA, for which the IRS may assess excise tax.
In this event, the plan sponsor should do the following to remedy the situation.
- Immediately deposit the funds, adjusted for any “missed” earnings, to the plan participants’ accounts.
- Determine the amount of the excise tax. An explanation regarding the excise tax is provided here.
- Complete IRS Form 5330, reporting the prohibited transaction and related excise tax, and file the form with a check for payment of the tax.
IRS Form 5330
IRS Form 5330 is used to report and pay taxes for a number of purposes. In connection with 401( k) plans, it is used most often to report the excise tax penalty incurred for failing to timely deposit employee 401( k) deferral contributions.
The excise tax is calculated based on the earnings “missed” by plan participants due to the late deposit of deferrals to their accounts. A late deposit results in a prohibited transaction under the Internal Revenue Code, and excise tax is imposed as a result.
Why does this happen?
The IRS penalizes a company for not contributing employee contributions stated on payroll to their 401(k) provider in a timely manner (15 business days). Late employer match contributions do not apply. The reason for paying the employees interest is because if they had received their 401( k ) deductions on time into their respective accounts, they could have potentially made that investment interest in the market.
Under federal law, it is the responsibility of the plan sponsor to properly prepare and timely file Forms 5330.
For information on how to complete and file an IRS Form 5330, please consult with your attorney or other professional tax advisor. Zenefits does not prepare Forms 5330 and does not offer tax advice or any tax preparation services.
It is the client's responsibility to file and send the form to the IRS.
How late interest is calculated
If employee funds were not deposited in a timely manner, the IRS requires a lost earnings calculation to be completed on those funds. This is done using the Department of Labor calculator.
How the excise tax penalty for late deposit 401(k) deferrals is calculated
In general, the excise tax penalty is equal to 15% of the "amount involved." The amount involved is defined by the IRS as the "missed" earnings attributable to the deposited funds.
The Department of Labor (DOL) offers an online calculator that can be used for this purpose. Use of the DOL calculator is not mandatory.
Plan sponsors should consult with their professional retirement plan administrators, attorney or professional tax advisor to properly determine the amount of the excise tax and report it on IRS Form 5330. Zenefits is not a tax advisor and does not provide tax advice or complete Form 5330 for companies.