Auto-enrollment and auto-escalation 401(k) features have gained wide acceptance as a means of boosting employee participation and deferral levels. But an inadvertent clerical error in the operation of those systems can prove costly to plan sponsors. Advisers can add value to their service to business clients by alerting them to these pitfalls pointing them to possible payroll systems slip-ups, or perhaps even doing a spot check themselves every now and then.
One of the most common problem areas is failing to start the prescribed auto-deferrals or auto-step-up in deferrals when they are supposed to kick in, according to Kari Jakobe, a Minneapolis-based principal and operations manager for Millimans employee benefits consulting practice
In a recent memo to Milliman clients, Jakobe illustrated a scenario in which an employer could find itself needing to contribute nearly $9,000 on account of clerical errors with respect to four 401(k) participants. For a small employer, the pain both in dollars and loss of credibility with affected employees could be significant.
Employers are subject to these obligations if the period during which deferrals and matching contributions were not made exceeds three months. When that happens, the employer must pay half of the missed deferrals (which otherwise would have been paid by the employee) and 100% of the missed match, plus assumed earnings at a reasonable interest rate, Jakobe explains.
Heres how it could work, using a somewhat extreme case to make the point. Suppose an employee with an $80,000 annual salary (i.e. $6,666.67 monthly) is supposed to default into the 401(k) plan at a 4% automatic deferral rate, with a 100% employer match up to the first 6% of compensation. That is, a total of 8% should be going into that employees account.
Suppose further that the deferral never happened, and this oversight wasnt detected until a year later. That employee should have had $3,200 (4% of $80,000) deferred, plus had another $3,200 deposited into her account from the 100% matching employer contribution.
In that scenario the employer would have to kick in $5,184: $1,600 (half of the intended $3,200 deferral amount), plus $3,200 (100% of the forfeited match) and another $384 in interest based on an 8% assumed return over the course of the year on $533 monthly contributions of combined deferrals and matching contributions.
In Jakobes illustration, the earnings levels and duration of the payroll error of the remaining three were less severe, adding another $3,753 in obligations leading to a total employer required outlay of $8,927. Even with stellar recordkeeping in place, things can go wrong with systems, data and the people involved, Jakobe warns.
Stolz is a freelance writer based in Rockville, Md.
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