Q&A: Plan Compliance Reviews

May 10, 2016

The rules governing employee benefit plans have always been complex and full of traps for the unwary. Errors in plan design, administration and fiduciary matters have created potentially significant issues for plan sponsors and fiduciaries. In the past decade or so, changes in the regulatory environment and legal climate have increased the risks associated with errors involving plans. The following Q&A addresses ways to mitigate the risk associated with such errors — and reduce potential liability in the event errors do occur — via plan compliance reviews.

Q:   What is a plan compliance review?

A:   A plan compliance review is a process in which a plan sponsor reviews the design and administrative operation of the plan in an effort to identify any issues or errors that could create risk for the plan sponsor and/or plan fiduciaries. The goal of the review is to identify and self-correct problems before they become larger and more costly — and before a governmental agency or plaintiff brings claims in connection with the situation.

Q:   Why is it important to conduct compliance reviews?

A:   A compliance review can reduce risk and financial exposure to the plan sponsor and plan fiduciaries. If a plan is not designed and operated in compliance with all applicable laws, the plan’s sponsor and/or fiduciaries can be required in some circumstances to pay losses, interest and penalties in connection with any errors that have occurred. Audits and enforcement actions by governmental agencies against plan sponsors and fiduciaries — as well as lawsuits by participants or groups of participants — have become increasingly common since the early 2000s.

Q:   What are some of the risks compliance reviews can reduce?

A:   Employee benefit plans are subject to requirements imposed by the Internal Revenue Code and/or the Employee Retirement Income Security Act of 1974 (ERISA) and, in some cases, other laws. Plans that are out of compliance with code requirements can lose their tax-advantaged status. Plans that do not comply with ERISA requirements create a risk of enforcement actions by the Department of Labor (DOL) and lawsuits for benefits and/or breaches of fiduciary duty. Plan sponsors and plan fiduciaries generally bear the financial burden when compliance issues occur.

Q:   Are these risks really that serious? They sound a bit theoretical.

A:   Yes! These are real risks. There are many real-world examples of plan sponsors and plan fiduciaries that have encountered problems in the areas discussed previously. DOL audits, claims for benefits and lawsuits regarding benefits and fiduciary duties are particularly common (and seem to be increasingly widespread in recent years). Although plan disqualification is not as common, a vast majority of plan sponsors settle with the IRS before the IRS seeks disqualification. Those settlements can be very costly and can involve the payment of substantial penalties to the government.

Q:   How often should a compliance review be performed?

A:   There’s just one hard-and-fast rule: Plans shouldn’t have just one compliance review. Beyond that, the answer can differ for different plans based on a number of factors. Some compliance review activities should be performed annually; other activities can be scheduled less frequently — once every two to four years, for example.

Plan sponsors should review their plans with legal counsel at least once each plan year to ensure that any legally required plan design changes (and any other design changes that the plan sponsor elects to make during the plan year) have been properly incorporated into the plan documents. Other aspects of a compliance review program should be performed regularly; however, they can be less frequent. For many plans, I recommend a more comprehensive review once every two to four years. The exact frequency will depend on a number of factors, including among other things the number of participants in the plan, the amount of contributions to and plan assets in the plan, the resources of the plan sponsor (both financial and administrative), whether the plan is subject to an annual audit requirement, and the thoroughness and complexity of procedures the plan sponsor has established to promote operational compliance.

Q:   Larger plans are required to have audits performed annually by an independent accountant. Should those plans also perform compliance reviews?

A:   Yes, I do recommend compliance reviews for larger plans that are audited annually. While audits can and do detect errors in plan design and operations, they are not designed to detect every error. This is no way means that a plan auditor isn’t doing his or her job — it simply means that plan audit standards and methods are not designed to ensure 100 percent compliance.        

Q:   The IRS and DOL allow plan sponsors and fiduciaries to voluntarily correct errors during audits and enforcement actions. Why not just wait for an audit and correct any errors then?

A:   It’s always better to self-detect and self-correct — before outside parties discover an error. First, when compliance reviews are performed frequently, errors do not remain outstanding as long. Therefore, the magnitude and cost of the errors that are detected are not as great. Second, many errors (especially those that are detected within a couple of years) can be corrected via self-correction without any formal disclosure to or approval of any governmental authority. There is no “fee” or “penalty” associated with self-correction. However, when errors are detected during an audit or via an enforcement action, the IRS and DOL seek to impose penalties. Those penalties can be very large in some cases. Finally, the compliance review process itself raises awareness of all of the rules and requirements that apply to the plan. This increased awareness alone can decrease the chances of an error occurring in the first place. This impact alone often justifies the implementation of a compliance review program.

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