Answering Your Fidelity Bonding Requirements Questions

As a retirement plan sponsor, you should be aware that every person who handles the property or funds of the plan must be bonded. A field assistance bulletin (FAB) issued by the U.S. Department of Labor provides guidance on fidelity bonding requirements. Understanding these requirements fully will help protect your plan and your business.

The bulletin includes the following information about applying the fidelity bonding requirements.

What is the purpose of a fidelity bond? The purpose of a fidelity bond is to protect your organization’s retirement plan from risk or loss due to acts of fraud or dishonesty by individuals handling the plan’s assets. These acts include theft, embezzlement, and forgery.

Who must be bonded? Generally, plan fiduciaries and any other person who handles plan funds or other property (a “plan official”) must be bonded. For example, officers and employees of the plan or plan sponsor who handle the receipt, safekeeping, and disbursement of plan funds are subject to bonding. Service providers and fiduciaries don’t need to be bonded if they don’t handle plan funds or property. Several specific exemptions also are included in the pension law.

What is meant by “handling” plan funds? Generally, “handling” plan funds refers to activities that pose a risk that the funds or property could be lost in the event of fraud or dishonesty, such as:

  • Physical contact with cash or checks
  • Power to transfer funds or property from the plan to oneself or a third party
  • Authority to direct disbursement
  • Authority to sign checks or other negotiable instruments
  • Supervisory or decision-making responsibility over activities that require bonding

How much coverage must the bond provide? Each plan official must be bonded in an amount equal to at least 10% of the amount of funds he or she handled in the previous year, with a minimum bond requirement of $1,000. Generally, the maximum bond amount that can be required for any one plan official is $500,000 per plan. However, the maximum required bond amount is $1,000,000 for plan officials of plans that hold employer securities.

Is a fidelity bond the same as fiduciary liability insurance? A fidelity bond is not the same as fiduciary liability insurance. Fiduciary liability insurance is additional coverage that generally protects the plan against claims for losses sustained because of a plan fiduciary’s breach of duty.

Can any bonding or insurance company issue an ERISA fidelity bond? No, fidelity bonds must be placed with a surety or reinsurer that is named on the Department of the Treasury’s Listing of Approved Sureties, Department Circular 570 (http://fms.treas.gov/C570/c570.html).

Are any plans exempt from the bonding requirements? Plans that are completely unfunded or not subject to Title I of ERISA are exempt from the bonding requirements. An unfunded plan is one that pays benefits only from the general assets of the organization.

Can a bond insure more than one plan? If your organization sponsors more than one retirement plan, you can purchase one bond to cover all of your plans. However, the bond’s amount must be sufficient to allow for a recovery by each plan in an amount at least equal to the amount that would have been required for each plan under separate bonds.

Can the bond have a deductible? No. The bond must provide coverage from the first dollar of loss up to the maximum amount required.

If the amount of funds handled by the plan increases after the bond is purchased, must the bond be updated during the plan year?No. The bond amount must be fixed annually (or estimated at the beginning of the plan’s year pending receipt of necessary information) for each covered person based on the highest amount of funds handled by that person in the preceding plan year. So the bonding amount can change from year to year, but not during the year. If the plan doesn’t have a complete preceding reporting year, the amounts covered must be estimated.

Correcting Excess 401(k) Contributions

SITUATION: When we conducted our annual nondiscrimination testing, we found that several of our highly compensated employees had contributed disproportionately more to our 401(k) plan than lower paid employees. Our plan failed the “actual deferral percentage” (ADP) test for the first time.

QUESTION: What do we need to do?

ANSWER: To avoid possible plan disqualification, you need to correct the excess contributions.

DISCUSSION: The ADP test compares the average rate at which highly compensated employees defer salary with the average deferral rate for nonhighly compensated employees. The difference between highly paid and lower paid employees must be within certain limits. If it isn’t, you need to correct the excess contributions. You basically have three options.

Distribution option. The plan can return the excess contributions and any plan income attributable to those contributions to the appropriate highly compensated employees within 12 months of the close of the plan year. However, if the distributions are returned more than 2½ months following the close of the plan year, the employer is subject to a 10% excise tax. For plans that are “eligible automatic contribution arrangements,” corrective distributions can be made up to six months following the end of the plan year without incurring the excise tax. The distributions are taxable to the employees.

Recharacterization option. Alternatively, the plan can recharacterize the excess contributions as after-tax contributions. To do so, your plan must have a provision allowing such contributions, and the recharacterization must occur no later than 2½ months after plan year-end. Amounts recharacterized as after-tax contributions are includable in the highly compensated employees’ income for federal income-tax purposes.
Or instead, if the plan allows, an excess contribution made by an employee who is age 50 or older may be treated as a catch-up contribution to the extent the employee hasn’t already made the maximum allowable catch-up contribution for the year.

Additional contributions option. Another alternative is to make qualified nonelective contributions
(QNECs) or qualified matching contributions (QMACs) for nonhighly compensated employees. Such contributions will be treated as elective contributions for ADP testing purposes.