DAVID W. D. CORE
PINNACLE FINANCIAL SERVICES, INC.

Touché- a French word meaning to parry and thrust, hit your mark, and score your point.

Professional Employer Organizations must artfully parry the IRS's 401(k) audit thrust to provide further support to the PEO's role as the employer. A correct PEO 401(k) plan is one opportunity to prove that the PEO is taking the employer responsibilities seriously.

A successful 401(k) plan is built upon four cornerstones, each one providing support and strength to the plan:

• proper plan design
• effective plan administration
• an appropriate investment program
• effective communication system

Let's begin by discussing effective plan administration. When operating your plan, you must consider the basic Internal Revenue Code sections and requirements that are most likely to be reviewed in the event of an audit. An audit is a battlefield and your strategy will determine your success. The thrust of this article is to give you strategies which will offer you the ability to have your most effective result.

One main area of concern is eligibility. When offering a 401(k) plan, the employer promises to provide the plan to all eligible employees. Eligibility issues may offer a diligent auditor an opportunity to compromise the PEO 401(k) retirement plan. Eligibility is a difficult challenge for the PEO because there are multiple layers of employee communications:   the 401(k) plan participant the client of the PEO the PEO the administrator the investment company

DAVID W. D. CORE

Eligibility is determined by hire date, age, and hours worked during a specific period. The record keeping system you adopt should review compensation and contributions on an ongoing basis. When compensation is received, the eligibility time clock begins. A system that audits monthly compensation initiates the link which allows your record keeper to determine when that 401(k) participant is eligible.

The second issue of audit concern is the salary deferral. In a 401(k) plan, a primary obligation of the employer is withholding employee contributions (salary deferrals). Procedures and audit controls to ensure that the intended salary deferral matches the actual dollars being withheld are essential. This may be a primary source of liability to the PEO because one may ask, "Who is responsible if an individual elects a particular percentage and that percentage is not withheld?"

If your plan is audited, it is certain that salary reduction election forms will be requested and reviewed to determine that the PEO withheld the percentage and/or amount that was directed by the participant. Your record keeping system should include an "Internal Policeman." By reviewing each contribution and comparing the actual deferral, a variance report can be generated.

Our next concern is IRC Section 415. This may also be a 401(k) plan disqualification issue. To simplify Section 415, no single individual can receive contributions (including salary deferrals) which exceed 25% of their reduced compensation, or $30,000, whichever is less. Many employers do not know that salary deferrals under Section 125 plans must be included in the Section 415 testing process. If they do not know this, an astute IRS auditor would hit "paydirt" if they did not include the Section 125 deductions.

Your record keeping system should verify, with each contribution, that year- to-date contributions as a percentage of year-to-date compensation is below the required IRC Section 415 limit. Look further. Be sure that your record keeping system provides a specific report stating that they are below the limit, and provides information as to how much in additional contributions a participant may make while keeping within IRC Section 415 compliance. This will allow you to be responsive to your clients when they ask you how much more they can participate in the 401(k) plan.

Another concern is accurately investing participant contributions according to the participant's specified investment allocation formula. We have found that this is a common and consistent error in plans that we review. With the multiple layers of management in a PEO, this could become even more complicated. It is extremely important that you address this issue for two reasons. This is an ERISA issue (which involves the Department of Labor) and you have a fiduciary liability. Imagine this scenario:

In 1995, a participant in your plan had $100,000 invested. They had elected an investment account which produced a 32 percent rate of return. Unfortunately, due to an administrative error, the funds were invested in a fixed income account which 'earned six percent. Who would be responsible for the several thousands of dollars that would have been lost to the participant in accumulation?

We recommend that you should not rely directly on your investment company for accuracy. This could be like having the fox guard the hen house. Independent audit control to determine the accuracy of j contributions into the accounts designated by the participants is a prudent course of action. Although you may be able to persuade the investment company to make adjustments to your participant's accounts, it will still cost you time (your most precious resource). An independent audit system compares the investment company's allocations with intended allocations ensuring their accuracy.

A final consideration is the reduction of fiduciary liability through ERISA Section 404(c). Effective in 1994, Section 404(c) allows employers and trustees to reduce or eliminate their fiduciary liability with regard to the investment decisions of their participants. Establishing a system to satisfy 404(c) will help you, the PEO 'owner, to provide an investment platform which reduces your liability.

Section 404(c) has three primary criteria:

Information and materials must be provided to the participants in a way that allows them to make informed investment decisions.

Participants must have the ability to make investment changes in their accounts at a frequency that is relevant to market volatility.

The participants must have the ability to diversify by investment class (stock, fixed income, etc.) and style of investment (risk characteristics).

When selecting your investment accounts, look for factors which satisfy 404(c). Do you have adequate educational materials? Do your participants have daily access to information about their investments? Can they move funds on a daily basis? Do you have an adequate mix of investment classes? Are all of the money managers from one fund family or can you choose from a variety of money managers and financial institutions?

PEO 401(k) plan, but a stronger PEO industry.

David W. D. Core is a Certified Financial Planner, a Chartered Financial Consultant, and a Certified Life Underwriter. In 1984, he founded Pinnacle Financial Services, Inc. with the primary focus of reducing the employer effort in providing a 401(kJ plan to their employees. In 1994, armed with the belief that the PEO industry is, and would continue to be, one of the fastest growing industries in the country, he began to develop the PEO 401(k) `Dream Plan. "For information on the "Dream Plan," you may contact him at (800) 375-PLAN (7526).

David W.D. Core is a registered representative of, and securities offered through, Lincoln Financial Advisors Corp.