This article answers some frequently asked questions about late payroll submissions and how to correct the late deposit.
My Payroll Submission Was Late … Now What?
The Department of Labor (“DOL”) requires that retirement plan contributions withheld from employee' paychecks be deposited timely, but their definition of “timely” depends on the size of the plan and, in some instances, the Plan Sponsor’s past payroll practices. A “small plan” (one with less than 100 eligible participants as of the first day of the plan year; please see How to Count the Number of Participants for more information about how to determine if your plan is “large” or “small” as defined by the DOL ) has an outer limit of seven business days to deposit participant contributions before they are considered late. Unlike small plans, a “large plan” must deposit participant contributions on the earliest date the employer can reasonably separate them from its other company accounts.
You should think of those guidelines as just that - - guidance. The best practice to follow with your payroll provider or payroll department is that participant salary deferrals and loan repayments should be (and the DOL generally expects them to be) deposited the same day or the day after they are withheld from employees’ compensation. Once withheld from paychecks, those plan contributions become plan assets as soon as they can be reasonably separated from the Plan Sponsor’s corporate assets.
Are there any penalties if payroll is late?
Yes, on two fronts. First, the DOL considers late payrolls to be what it calls a “prohibited transaction” because by failing to timely separate its participants’ contributions to the plan from its corporate assets, it views the employer as improperly having made a loan to itself and having control over those assets. The DOL requires the Plan Sponsor to pay any earnings that the affected participants would have received from the date the deposit should have been made through the date the deposit was made. Although beyond the scope of this article, it is worth noting that the relevant time period for calculating lost earnings may differ for sole proprietorships, partnerships, 403(b) plans, and potentially for large plans depending on their past payroll practices.
It should also be noted that, technically, the DOL has not officially approved the payment of lost earnings as a correction method, but a common and accepted practice in the industry at this time is that payment of lost earnings satisfies the DOL’s compliance requirements.
In addition to the payment to those lost investment earnings that any affected participants missed as a result of the late contributions, the Internal Revenue Service (“IRS”) requires Plan Sponsors to pay a 15% excise tax on the total amount of those lost earnings. The excise tax is submitted to the IRS by filing a Form 5330. – If your organization uses Vestwell’s bundled services, we will file Form 5330 on your behalf. You can find more details about Form 5330 in our Help Center.
What are lost earnings, and how are they calculated?
As explained in our Corrections Policy, we will determine the appropriate calculation method for any required correction consistent with DOL and IRS guidance. Depending on the nature and size of the plan and the length of any delay, we may use a calculator provided by the DOL to calculate those lost earnings.
When are lost earnings due, and how are they deposited?
As a convenience to employers, the Vestwell platform automatically detects any participant salary deferrals or loan repayments deposited to the plan after the seven-day window, then calculates and deposits the lost earnings owed to the affected participants. That additional compensation is deposited to the contribution source affected, whether the employee pre-tax deferral or the employee Roth deferral. The lost earnings are recorded as participant account earnings, not an additional employee contribution.
Who pays for the lost gains?
Consistent with Vestwell’s Corrections Policy, Vestwell accepts responsibility for the payment of those earnings to the extent it is responsible for the late contribution, but in all other instances, we reserve the right to add the total compensation paid to affected participants to the Plan Sponsor’s next quarterly invoice.
How does this affect my plan’s Form 5500?
In addition to reporting late deposits on Form 5330, as explained above, they must be reported to both the IRS and DOL via Form 5500 or Form 5500-SF (for small plans). The total amount of late deposits (employee contributions plus loan repayment amounts) for the plan year, plus any carry-over deposits from prior plan year(s), must be reported iForm 5500. If a late deposit is not corrected within the plan year, it must be reported on subsequent Form 5500s until it is fully corrected.
It is also the DOL’s common practice to send a letter to the Plan Sponsor if any late deposits are reported on the Form 5500 because it does not always cross-check that excise taxes were paid via the Form 5330 mentioned above. If that happens, please send us the letter so that we can assist in preparing a response.
What about early deposits?
Employers may know the amounts to withhold for participant contributions a few days before the pay date and you may be wondering if you can avoid the risk of a late deposit entirely by just depositing all salary deferrals and loan repayments early. Unfortunately, although with limited exceptions beyond the scope of this article, IRS regulations prohibit depositing plan contributions before the employee completes the work, so an early deposit is not an alternative approach.
In our experience, most payroll providers have a solution available to make sure deposits are made on time. As a reminder, as we explained in the Plan Adoption Agreement Guide that was provided to you with your plan documents, it is your responsibility to confirm with your payroll provider that it has set up your company’s payroll files to be consistent with the plan features that you selected.
If you need additional assistance, don't hesitate to get in touch with us at clientsuccess@vestwell.com.