The Achilles Heel of All 401(k) Plans: The Payroll Interface

When someone asks me what I do for a living, I typically respond that I’m an investment adviser focused on managing large 401(k) plans for companies. What I should say, however, is that I’m a payroll triage specialist, because I spend an inordinate sum of time discussing, or fixing, payroll-related problems.  Surprisingly, for all the talk about the liability associated with plan fees and investments, we hear so little about the real Achilles heel of retirement plans: the interface between the payroll system and the plan’s recordkeeping system. 

Nine of my last 15 client meetings included committee discussions about issues that arose involving the payroll and plan systems; a correction was required in almost half of them. I was initially concerned that we had not offered proper advice, but two of my last three new clients had payroll issues before they arrived. This has led me to the unscientific conclusion that payroll problems could potentially be affecting a huge number of plans. The plans may not realize it yet, but, at some point, these problems will come to light. They can be expensive errors to correct: Our firm has seen corrections well in excess of $100,000 for plans with fewer than 500 employees.

Early detection is the best prevention, so, in an effort to help sponsors uncover these payroll gremlins, I’ve detailed the characteristics of the most common failures we have confronted, in order to establish some risk factors.

Risk Factors

Any of the risk factors below can cause a payroll failure, but plans that have two or more exhibit elevated risk. These factors are listed in descending order of the likelihood that an incident will occur.

Inexperienced or untrained payroll personnel. Payroll sits at the intersection of human resources (HR), compensation and benefits. It is, therefore, the operational nexus of employee satisfaction, and the person in charge is critically important. The most common mistake we see originates with a payroll person who works according to the “data in/data out” model. This creates tunnel vision that allows errors to slide by undetected. I was recently shocked to learn that one of my client’s payroll techs did not know the statutory contribution limits. How can a person in that position effectively manage the payroll-plan interface without understanding its most basic limit?

The best practice is to ensure your payroll personnel understand how the payroll and plan systems interact. They need to understand the limits—both statutory and plan-based—and be familiar with potential problem areas, best practices and plan changes.

Multiple payroll sites. Organizations with multiple payroll sites­—meaning the payroll is managed by individuals at different locations—are the most likely groups to have a problem. Maintaining a clean sync between payroll and the plan is about process and controls. The more variables, the more likely you will have a problem.

Multiple payroll sites typically happen through acquisition. Different payroll providers and payroll cycles make it easier just to leave current systems in place. Unfortunately, this almost always leads to an error.

The best practice for an organization with multiple payroll sites is to develop a plan to consolidate those sites into one. If this is not possible, then considerable oversight and double-checking procedures need to be put in place to ensure that nothing gets missed. The key is to eliminate as many variables as possible:

• Can you consolidate to one payroll vendor but maintain separate pay dates?
• Are your deduction codes the same across each payroll site?
• Is a uniform training procedure used with each responsible employee?

Multiple EINs. Over the past few years, we have seen an increase in the number of organizations that use multiple employer identification numbers (EINs) to pay different groups of employees. This is particularly prevalent in organizations that are growing or that regularly open new locations in different states. Unfortunately, one of the most common errors we confront is that the new EIN does not get added to documents before they get added to payroll, which makes any employee who participates under that EIN ineligible.

This is less of a payroll problem and more a problem that payroll can help fix. Payroll personnel should be trained to verify that any new EIN has been added to the plan document before deferrals are allowed.

Auto-enrollment. I was an early skeptic of automatic enrollment, but now I recommend it to almost every plan. It is, without question, one of the most effective ways of boosting plan participation. It will also likely cause an error in your payroll at some point. The most frequent issue we see is missed employees. 

Fortunately, the Department of Labor (DOL) and Internal Revenue Service (IRS) have relaxed the rules for correcting auto-enrollment failures, making it significantly easier and less expensive for the sponsor.

Unfortunately, the best practice for preventing an auto-enrollment failure is not automatic at all. The best method to foolproof your auto-enrollment is to spot-check a reasonable number of employees each enrollment period to make sure they are properly registered in the plan and payroll systems. It may take you 15 minutes, but it can save hours of work and lots of money down the road.

Payroll providers. The natural question to ask is whether your company’s choice of payroll provider makes a difference in how often errors occur. As tempting as it is to put a certain well-known provider on notice for all of the heartburn it has caused my clients, it should be noted that these types of errors occur at all payroll providers. Yes, we have seen a substantial portion of errors at one provider; however, that may simply be due to the fact that it is one of the largest providers out there.

Regardless of their vendor, sponsors should take a step back and evaluate:

• How hard, or easy, is it for employees to enter plan data into the payroll system?
• Does the payroll system support warnings and reports on specific limits and controls? For example, will it flag a participant who defers in excess of the limit? Or who misses a loan payment?
• Does the payroll system integrate with the plan’s recordkeeper to make data transfer seamless?
• Is 401(k) plan-related reporting from the system clear and easy to use? Or does it need to be manipulated?

Putting it all together. The best analogy I’ve heard for the relationship between payroll and 401(k) plans is that of a busy interstate. Each of your participants is a car that’s entering the highway, changing lanes and exiting. Just like the design of the highway, the way a company designs its payroll-to-plan interface plays an important role in whether there is an accident. Companies also need to recognize that the design of their highway will need to change as the number of cars increases. Failure to increase capacity can lead to traffic jams and accidents, which can prove costly to an organization.

Andrew Zito, AIF, is executive vice president, retirement plan services, at LAMCO Advisory Services, an independent retirement plan consulting and advisory firm.