Safeguarding Participant Contributions to Your 401(k) Plan

March 30, 2020Alerts

In light of the economic disruption created by the COVID-19 pandemic, employers are exploring all available avenues to cut costs. Many are wondering about the ability of employers to defer or eliminate contributions to 401(k) and other types of retirement plans.

It is critical to understand that any ability to defer or eliminate 401(k) contributions applies to employer contributions only. Under no circumstances, may an employer defer participant contributions to a 401(k) Plan.

Participant contributions do not belong to the sponsoring employer and employers are subject to strict U.S. Department of Labor rules. These rules mandate that participant contributions be deposited into the Plan as soon as they can be reasonably segregated from the employer’s general assets, but in no event later than the 15th business day of the month following the month in which the contributions are deducted. It is important to understand that the “15th business day” requirement is not a safe harbor.

In general, the Department of Labor takes the position that, in most instances, participant contributions can be segregated within three to five business days. There is a safe harbor rule for smaller employers mandating that contributions be deposited into the 401(k) plan within seven business days.

Penalties for violating these requirements can be severe. Even if the deposit is only a few days late, it is treated as a prohibited loan from the Plan, giving rise to imposition of interest and an excise tax. If the contributions are significantly delayed, consequences can be more onerous, including imposition of personal liability on the individuals responsible for the decision to delay payments to the Plan, as well as the likelihood that the Department of Labor will likely seek enforcement in federal court.

Many employers do not risk a violation because they utilize a payroll service that seamlessly transfers participant contributions directly to their 401(k) plan. However, smaller employers are often more directly involved the payroll process and play a role in the transfer of participant funds into the 401(k) plan from Company assets. All things being equal, smaller employers will be more acutely affected by the current financial crisis and should be mindful of the need to protect the integrity of participant contributions.