Posted by Maria Hurd, CPA
When auditors identify operational errors, clients and service providers often ask whether we can ignore them since they are immaterial to the financial statements. It’s true that auditors must apply materiality to evaluate the effects of identified misstatements on the audit and the effect of uncorrected misstatements on the financial statements. Although in planning the audit, auditors use tools to quantify a materiality level at which a misstatement will be considered material, they also evaluate the size and the nature of each operational error, and the specific circumstances that caused it, in order to evaluate its effect on the financial statements. When an error is identified, an auditor must evaluate whether the error is an isolated incident, or whether additional participants were affected, and the effect on the financial statements. Often, operational errors found during retirement plan audits are, in fact, immaterial to the financial statements, but they also represent operational errors for which there is a correction suggested in EPCRS. Auditors’ recommendations to correct operational errors generally adhere to the EPCRS guidance of what constitutes a de minimis amount and when it is appropriate to make estimates.
Making Participants Whole: Does Materiality Play a Role?
The EPCRS states that: “In general, a failure must be fully corrected. Although the mere fact that correction is inconvenient or burdensome is not enough to relieve a Plan Sponsor of the need to make full correction, full correction may not be required in certain situations if it is unreasonable or not feasible. Even in these situations, the correction method adopted must be one that does not have significant adverse effects on participants and beneficiaries or the plan, and that does not discriminate significantly in favor of highly compensated employees.”
As such, there are certain permitted exceptions to full correction of plan errors that allow employers to achieve compliance efficiently. For example:
- Corrective distributions of $75 or less
- Distributions for which the costs of delivery are higher than the distribution amount
- Recovery of overpayments to participants of $100 or less
- When computing earnings, corrective allocations MUST include gains and MAY be adjusted for losses.
Note that the exceptions to full correction eliminate the need to take small amounts of money OUT of participant accounts, in the interest of efficiency. However, EPCRS specifically states that this exception does not apply to corrective contributions to participants with accounts under the plan, “which are required to be made.” If the participant who is owed an omitted contribution is still employed by the company, the IRS would likely prefer that a restitution be deposited, even if an estimate must be made to complete the correction in a cost-effective manner.
The EPCRS states that: “If either
- it is possible to make a precise calculation but the probable difference between the approximate and the precise restoration of a participant’s benefits is insignificant and the administrative cost of determining precise restoration would significantly exceed the probable difference or
- it is not possible to make a precise calculation (for example, where it is impossible to provide plan data), reasonable estimates may be used in calculating appropriate correction.
Examples of Reasonable Estimates
EPCRS provides several specific examples of situations in which estimates are appropriate:
“If it is not feasible to make a reasonable estimate of what the actual investment results would have been, a reasonable interest rate may be used. For this purpose, the interest rate used by the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator (“VFCP Online Calculator”) is deemed to be a reasonable interest rate. The VFCP Online Calculator can be found on the internet at http://www.dol.gov/ebsa/calculator.”
Missed Elective Deferral Deposits
An employer that misses a series of elective deferral deposits into the plan can assume that all missed contributions would have been made on the midpoint of the plan year, or portion of the plan year in which the omission occurred. This method is a practical alternative to computing up to 52 separate interest calculations. In this case, the results of an exact calculation would not be significantly different than those of an estimated contribution date in the midpoint of the omission period.
A Penny Saved is a Penny Earned
Arguably, small and rounding errors that would result in additional contributions of less than a dollar per person could be considered trivial enough to be overlooked. The danger lies in the subjective determination of what’s trivial and who makes the call. Most employers would say that a correction amounting to an additional $5 per person is too trivial to complete, but would an employee who contributes $5 per paycheck think the same way? Maybe, maybe not. As everything else in our field that is not black and white, what constitutes an amount so trivial that it is de minimis can be in the eyes of the beholder. Although we strive to be reasonable in our audit recommendations, there is always a chance that a regulator would take the position that a penny saved is a penny earned, so it should be contributed.