How to Stay Afloat in a Changing Economy: the Ins and Outs of 401k's and Tax Audits

October 2008

By Lance Wallach


Government officials now expect 401(k) plan sponsors to conduct periodic due diligence reviews. With respect to their 401k or other retirement plans, the problem is that most sponsors (owners) do not have the in house resources to do so.

This is not something that 401(k) plans historically did. On the heels of the recent mutual fund scandals, though, Labor Department officials indicated that sponsors had a duty to periodically investigate plans and benchmark funds and fees.

Baby boomers are now retiring, and their 401(k) accounts often are their primary source of retirement income. A sponsor potentially could be liable for less than stellar 401(k) account growth if employees can claim that he did not meet his fiduciary duties.

Trusting the reputation of a major mutual fund company is not enough anymore. Sponsors must investigate and compare their plans to other programs at least every two to five years, as well as demonstrate that their plan expenses are in line with what others are paying. Blind trust is not prudent. You need a process, and you need to document that process.

Every fiduciary decision has to be made through a careful process. According to ERISA, the primary plan fiduciary is the sponsor, i.e., the employer.

Therefore, it is the employer's responsibility to ensure the prudent selection and oversight of plan vendors.

Sponsors must monitor vendors in two ways: micro monitoring, which should occur annually, examines plan features and services, while macro monitoring every three years or so allows sponsors to benchmark with competitors.

Smaller employers who comparatively lack resources and manpower find it difficult to monitor vendors to this extent. Thus, owing to ERISA provisions that compel bewildered sponsors to take on experts to help with due diligence, most small to mid sized plans will need to hire consultants.

There is potential liability if due diligence reviews are not conducted. Failure to engage in a prudent process may breach fiduciary duties, which may render the sponsor liable for damages. For example, if plan participants pay fees that are higher than the current market rate because the sponsor did not perform a review, that fiduciary could be liable for the higher fees.

But as long as the sponsor can prove he did a proper investigation, he can potentially shield himself from liability. The employer has to show that he engaged in a prudent process and that he made a reasonable decision based on that process. This applies to all retirement plans, not only 401(k) plans.

However, as the economy begins to falter, the risk of being audited becomes an increasingly higher risk. The IRS looks for some things on tax returns which make an audit of your return more likely. This includes putting too many zeros on a tax return. For example your are better off deducting $797 for charitable contributions than taking an $800 deduction. The IRS is looking to find people who guess, estimate, or make up numbers. An $800 deduction looks like an estimate or worse. A $797 deduction looks like you figured out the true amount of the deduction. When the IRS audits you they are looking to get money. If you have the exact numbers on your return they would not ordinarily end with a few 00. For business owners a good way to get audited is to take a low salary, having a retirement plan that has not been updated to reflect new laws, and having independent contractors, illegals, etc. as your employees.

Page 1 of 2 :: First | Last :: Prev | 1 2 | Next