Staying in compliance with 401(k) plan requirements is an important part of safeguarding your employees’ financial future and protecting your company from legal repercussions. By understanding the areas where you are most likely to fall out of compliance, you can address problems before they escalate into costly fines, penalties or lawsuits.
Here, we look at some of the most common 401(k) compliance issues, along with steps you can take to avoid them.
Five most common 401(k) compliance issues
1.) Timely remittance of employee contributions.
The Department of Labor (DOL) mandates that employers deposit employee contributions into defined contribution retirement plans in a timely manner. Small plans (those with fewer than 120 eligible participants), have up to seven business days but should ideally make their contributions within two to three business days. Contributions for large plans must be segregated from the employer’s assets as soon as administratively feasible but in no event later than the 15th business day after the month’s end in which the deductions from employees have been taken.
The “15th business day” guidance is not a safe harbor for depositing deferrals, and in most cases, the DOL would expect deposits to occur much more quickly than that. The DOL will look at how soon companies can segregate other payroll-related items from the company’s assets, such as withholding taxes, and will likely hold companies to that timetable for segregating employee 401(k) deferrals as well.
2.) Non-discrimination testing (NDT).
As tax-favored plans, 401(k) plans should benefit all participants. The IRS mandates that retirement plans conduct non-discrimination testing every year to ensure that plans are not favoring highly compensated participants. Companies that fail a non-discrimination test have a set amount of time to fix any failures of the NDTs. If failures are not corrected in a timely manner, retirement plans may face potential disqualification of the plan.
3.) Late filings.
Companies that miss the deadline for submitting Form 5500 may incur fines and penalties. To mitigate this, plan administrators can take advantage of the DOL’s Delinquent Filers Voluntary Compliance Program (DFVCP), so long as they do so before receiving a notice from the DOL. When a plan is delinquent, the DFVCP allows for voluntary compliance with the annual reporting obligations mandated by the Employee Retirement Income Security Act (ERISA) at reduced costs to the plan sponsor. Additionally, the DOL provides an online calculator to help determine the exact penalties due.
4.) Non-compliance with the plan document.
A plan’s operations, its plan document and its summary plan description must be aligned. This ensures a correct and consistent definition of eligible compensation; the inclusion of eligible employees and the exclusion of ineligible employees; and the proper administration of loans, rollovers and distributions. A plan sponsor that fails to adhere to the plan’s provisions risks breaking their fiduciary responsibility, which could lead to the disqualification of the plan’s tax-favored status, and the imposition of penalties and liabilities.
Companies realizing that a plan has not been operating in compliance with the plan document must make a good-faith effort to correct the issue(s) and involve an ERISA attorney in the correction process.
5.) Participant loans.
Some plans permit participants to take loans from their retirement accounts. In order to qualify, these loans must meet certain requirements for amount, duration and repayment. There are also requirements for loans made to owners and officers of the employer, which, if not met, may cause the loan to be considered a prohibited transaction. If loans don’t conform, the plan is generally considered to be out of compliance, and the amount of the loan may be taxable to the participant.
This can happen when, for example, an employee agrees to have repayments taken out of their paychecks, but the loan is not communicated properly to payroll, and repayments are not made as scheduled. While corrective actions can be taken for such issues, they are limited. Effective communication between relevant departments is essential for preventing these issues.
How to maintain compliance
Some basic safeguards can help you avoid 401(k) compliance issues altogether. Regardless of plan size, industry or experience, we recommend the following for all companies with a retirement plan:
- Work with knowledgeable service providers with expertise in retirement plans, including third-party administrators, retirement plan advisors and auditors.
- Designate one or more people internally, typically from finance or human resources, to monitor changes that may affect the plan.
- Have a process in place that enables employees who spot a problem to report it effectively.
- Do not ignore problems! Take steps to address them as soon as they become apparent.
How BPM can help you stay compliant
Failure to stay in compliance can be costly in both money and time. At BPM, we want to help save you both, which is why we do more than simply audit your plan. We’ll meet with you, educate you about your options and responsibilities, and make recommendations for service providers who are right for your needs. If you are facing 401(k) compliance issues, have questions or would like to discuss an upcoming audit, please contact us.
FAQs
Saving Too Little, Too Late — by Default
That's the good news — but also the bad news, because people tend to stick with the contribution rate they're assigned, and that default level is typically too low to fund a comfortable retirement.
What is the biggest mistake on 401k? ›
Saving Too Little, Too Late — by Default
That's the good news — but also the bad news, because people tend to stick with the contribution rate they're assigned, and that default level is typically too low to fund a comfortable retirement.
What is the top-heavy compliance test? ›
A plan is top-heavy when the owners and most highly paid employees ("key employees") own more than 60% of the value of the plan assets. This ratio is tested every year based on the account balances on the last day of the prior plan year.
What not to do with your 401k? ›
Taking an early withdrawal from your 401(k)
One of the most ruinous things you can do for your retirement is raiding your piggy bank, whether that means cashing it out or taking a loan or hardship withdrawal.
What is 401k compliance? ›
401(k) compliance testing ensures that investing for retirement is as fair as possible for all participants in the plan, and that the plan continues to receive favorable tax treatment from the IRS.
What 50 year old retiree says his biggest mistake was saving too much in his 401k? ›
A 50-Year-Old Retiree Says His 'Biggest Mistake' Was Saving Too Much in His 401(k). He Explains What He Would Do Differently and His Workaround for Being Illiquid When He Retired. Eric Cooper maxed out his 401(k) for more than two decades and accumulated enough to retire in his late 40s.
What is the unfortunate truth about maxing out 401k? ›
Unfortunately, if you are trying to max out this account, it could leave you with too little money to put in other plans such as an IRA, HSA, or Roth IRA. There's a big opportunity cost to giving up the benefits these other accounts offer, including access to a broader array of investment options.
How to fix a top-heavy plan? ›
To correct a top-heavy allocation failure, the employer must make a corrective contribution on behalf of the employee who received an insufficient allocation in an amount equal to the insufficiency, adjusted for earnings.
Do rollovers count towards top-heavy testing? ›
A plan is “top-heavy” if the account balances of key employees represent more than 60% of the account balances of all employees. Plan balances are adjusted to exclude unrelated rollovers* and most balances of terminated employees, but include loans and early distributions.
What is the compliance test method? ›
To conduct effective compliance testing, organizations often employ the control testing methodology. This approach involves a structured examination of internal controls and processes to determine whether they align with compliance requirements.
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
What are the new 401k withdrawal rules for 2024? ›
New rules make it easier to tap your retirement account for emergency funds. In 2024, you can cash out as much as $1,000 from a traditional 401(k) or IRA to cover an urgent need. And here's a big change: You get to define what counts as an emergency. More Americans are raiding retirement accounts for emergency cash.
What is the rule of 55 for 401k? ›
The rule of 55 is an IRS guideline that allows you to avoid paying the 10% early withdrawal penalty on 401(k) and 403(b) retirement accounts if you leave your job during or after the calendar year you turn 55.
What triggers a 401k audit? ›
Typically, an audit requirement is triggered when a retirement plan reaches 100 eligible participants (on the first day of the Plan year), which is considered a “large” plan. The 80/120 rule is an exception to this general rule.
How do I protect my 401k? ›
5 steps to protect your 401(k) investments
- Continue contributing to your 401(k) plan. First and foremost, don't abandon your retirement planning during a recession. ...
- Maintain a well-diversified portfolio. ...
- Consider investing in defensive stocks. ...
- Opt for value over growth stocks. ...
- Make room for income-producing assets.
Five most common 401(k) compliance issues
- 1.) Timely remittance of employee contributions. ...
- 2.) Non-discrimination testing (NDT). ...
- 3.) Late filings. ...
- 4.) Non-compliance with the plan document. ...
- 5.) Participant loans.
At least a portion of your 401(k) is likely exposed to the stock market, which is what helps it to grow over time. However, like with all investments, if the stock market dips—you could instead see declines in value from time to time, which may lower your 401(k) balance at certain points along your savings journey.
What is the bad side of 401k? ›
With a 401(k), you will have to pay income tax on your contributions and the investment gains when you withdraw funds from the account. “Without knowing for certain how your 401(k) will perform or what the taxes will be in the future, your 401(k) can be a ticking tax time bomb,” Rubio said.
What mistakes are most boomers making with 401k? ›
Financial Experts: 10 Retirement Mistakes Boomers Make (But You Don't Have To)
- Not Maxing Out Pre-Tax Accounts. ...
- Not Forecasting Your Retirement Financial Needs. ...
- Not Taking Your Distributions Properly. ...
- Leaving Old Retirement Accounts Untouched. ...
- Not Adjusting Your Risk Level. ...
- Not Utilizing a Money Market Savings.
But it gets worse. The stratospheric inflation, brought on by government spending, borrowing, and printing too much money, has further eroded the value of 401(k) plans by $16,200 on average, for a real (inflation-adjusted) loss of around $33,200, or 24.8%.
