Frequently Asked Questions

Late Deferral Deposits – What are the Rules, Exactly?

Some employees carefully watch their deferral contributions with each paycheck as they go into their 401(k) or 403(b) plan account. After all, it is their money – wages they’ve set aside to be paid later! But how quickly must the deposit be made? Employers often misunderstand the deposit timing rules for employee deferrals. In this article, we will explain the rules, exceptions, and consequences, along with the options available for fixing late deposits.

Have a procedure

Problems can occur when the employer’s deposit procedure does not exist or is not followed. Other times, the problem results from the payroll provider not understanding the deadline or not following their own procedures. Because of the penalties and costs involved, it is important that employers and payroll providers know the deposit deadline and establish a procedure to consistently meet that deadline.

The general rule

Salary deferrals, loan payments, and after-tax contributions must be deposited on time to avoid penalties and extra employer costs. See DOL Reg. section 2510.3-102(b)(1).

But what does “on time” mean? Once withheld from paychecks, deferrals and loan payments become plan assets as soon they can be “reasonably segregated” from the employer’s general accounts. That means ASAP – as soon as possible!

If deposited late, the employer has control over these plan assets. The Department of Labor (DOL) treats this as a prohibited loan from the plan to the employer for the entire time it stays under employer control.

The penalties for being late

The DOL requires the employer to pay extra amounts to make up for the lost earnings from the date the deposit should have occurred through the date the actual deposit is made. In addition, earnings on the lost earnings must be paid.

The IRS also applies a 15% excise tax on the lost earnings. This tax is paid using Form 5330. If the earnings owed are not paid in the same year the deposit was due, the 15% excise tax applies again in the next year. This continues each year until the error is fully corrected.

Exceptions to rule

Not all plans are affected. Plans maintained by churches or governments are exempt, as well as non-qualified plans under sections 457 and 409A. Deferral-only 403(b) plans and owner-only plans have less strict deposit timing rules. For these plans, check the plan document for the deposit deadline.

The 15% excise tax does not apply to 403(b) plans, but a late 403(b) deposit is still prohibited. That means the employer must only fund the late amounts and pay the lost earnings. In some cases, under ERISA section 502(i), the DOL could contact the employer to charge the 403(b) plan sponsor a 5% civil penalty on these missed earnings, but this rarely happens.

Some deposits may be late due to events outside the control of the employer. This could be anything unexpected, ranging from the accountant getting sick, to a natural disaster. When this happens, the employer should document the reason. The deadline may be treated as satisfied when this occurs.

Plan size affects the deadline

A small plan has less than 100 participants on the first day of the plan year. Small plan deferrals are not considered late if they are deposited with seven business days after being withheld. Otherwise, they are late and the missed earnings start earlier (see “Deposit Standard” below).

Unlike small plans, large plans do not have a precise deadline. Instead, the deposit deadline is the earliest date the employer can reasonably segregate the withholdings from its general assets. However, some DOL agents have stated the funds should be deposited the same day they were withheld!

Deposit Standard

If a deposit is late, missed earnings are calculated from the earliest date the employer could have made the deposit. This is true regardless of the size of the plan. This is known as the “Deposit Standard”. The DOL typically enforces this as 3 to 5 days after each payroll. However, if they see that the employer made deposits earlier than this in the past, that may be used to set the Deposit Standard, instead.

This is especially true for large employers. They often have staff to handle payroll and deposit any amounts withheld. The DOL expects them to make deposits very early. Large employers cannot rely on the seven business day rule that applies to small plans.

All employers should document their procedure for depositing withheld amounts to the plan. This practice helps establish the Deposit Standard.

Rules for partners and sole proprietors

Sole proprietors and partners do not receive actual paychecks like employees. This is true even if they take a draw from the company during the year. To defer, they must complete an election before the end of the plan year. However, no deferral deposits are required during the year. Instead, the deposit is normally due shortly after the CPA determines the net earned income for the year. In some cases, the deposit is due when the income, less deferrals, can be distributed to the partner (or sole proprietor). Regardless, the deposit cannot take place after the deadline for filing his/her individual income tax return.

Misunderstood guidance

You may have heard that deposits are due by the 15th business day of the next month after being withheld. This is not a deadline. Instead, it is an outer limit – anything later cannot be treated as being on time. The law requires the deposit to be made “as soon as possible”, as described earlier. If the plan is not covered by ERISA law, then it may allow a 15-business day deposit standard. In some cases, an even later deadline applies.

What about early deposits?

Employers may know the amounts to withhold a few days before the pay date. Therefore, they might assume they can make the deposit early, so it is on time. While this would satisfy the DOL’s deposit timing rule, IRS regulations prohibit depositing plan withholdings before the employee completes the work. However, when the employee responsible for making the deposit will not be working on the payroll date, a limited exception applies. See Treas. Reg. §1.401(k)-1(a)(3)(iii)(C).

Correction options

  • Do nothing. If late deposits have occurred, the Form 5500 reports this to the IRS and DOL. The DOL considers late deposits a fiduciary breach and they will ask if these have been corrected. The IRS may request excise tax payments. If no correction is made, the employer should expect a DOL investigation. The DOL has the authority to file a lawsuit and assess civil penalties.
  • Self-Correction. The DOL has not issued guidance to allow for self-correction for late deposits. However, it is common for employers to self-correct. First, employers should deposit all deferrals and loan repayments. Next, they can calculate the lost earnings using the DOL calculator. Then, they should allocate the earnings and file Form 5330 to pay the excise tax. Finally, employers need to be sure to report the late deposits on Form 5500.

Risks Associated with Self-Correction

If the DOL finds self-corrected late deposits, some DOL agents will approve the correction and search for other issues. However, other DOL agents may require the earnings to be determined using an actual rate of return.

Voluntary Fiduciary Correction Program (VFCP). The DOL’s only approved correction method is to file under the VFCP program. An application is filed with the DOL and includes:

  • a list of each fiduciary involved in the breach and the correction
  • an explanation of the breach, the date it occurred, and supporting documentation
  • a signed penalty of perjury statement by the fiduciary
  • an explanation of how it was corrected, by whom, and when
  • a statement of how the Deposit Standard was determined and supporting evidence
  • a description of the practice in place before the breach occurred
  • an exhibit demonstrating the calculation of lost earnings
  • proof that the corrective payment was made to the plan
  • proof of payment to separated participants
  • a copy of the most recent Form 5500
  • the relevant portions of the plan document and any other pertinent documents
  • a description of measures implemented to ensure the error does not happen again
  • a completed VFCP checklist

Also, a Form 5330 is filed with the IRS to pay the 15% excise tax on the lost earnings. This payment can be avoided if the plan provides a notice to the affected participants and files VFCP with the DOL.

There is no DOL user fee to file under VFCP. However, as you can see from the list above, the application is time-consuming. Most plan sponsors choose to not file under VFCP when the lost earnings are relatively insignificant amounts.

What to Remember

The Department of Labor (DOL) has a deposit deadline for salary deferrals and loan repayments. A late deposit is a prohibited transaction and participants lose potential investment earnings on those dollars. Thus, the DOL requires plan sponsors to contribute lost earnings to the plan to place the participants in the position they would have been if the failure had not occurred. The Form 5500 reports this to the IRS and DOL. The DOL may ask about the correction. The IRS may ask about the excise tax payment. If no correction is made, a DOL investigation should be expected.

Most employers self-correct by using the DOL calculator and filing Form 5330 to pay the excise tax. If the missed earnings are substantial (thousands of dollars), consider filing under VFCP with the DOL. This guarantees that the use of the DOL calculator for the missed earnings will be accepted.

The Role of the Payroll Provider

The payroll provider should have a solution available to assist plan sponsors with making sure deposits are made on time. If they do not, Goldleaf Partners’ payroll service does. Part of our payroll service includes the submission of withheld amounts to the plan’s trust by the deposit deadline. This service also provides a seamless integration to automatically provide the annual census information to our retirement team for handling the plan’s annual administration.

Regulatory Updates

IRS Releases Draft Forms 1099-R and 5498 for 2023 Tax Year

IRS Releases Draft Forms 1099-R and 5498 for 2023 Tax Year

The IRS has posted draft versions of Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., and Form 5498, IRA Contribution Information for tax year 2023.