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Top 5 401(k) Issues: A Compliance Guide For Employers

by Mary Wasielewski on Dec 29, 2020 4:29:34 AM

If you’re thinking of offering a retirement plan to your employees to boost satisfaction and retention, you may be worried about what’s required of you in terms of time and technical knowledge. And to be honest, that’s an understandable concern since 401(k)s are highly regulated and the rules make offering them complex. These complications also mean there’s the potential for missteps that can lead to an audit or penalties if you don’t get things right.

As a third-party administrator (TPA) for 401(k)s, our administrators work with clients in the Northeast to help design and administer retirement plans for their employees. At Complete Payroll Solutions we know how challenging the requirements are for 401(k)s and the importance of making sure you meet them.

To help you understand common pitfalls when offering 401(k)s so you can take action to avoid them with your plan, here we’ll discuss the top 5 compliance issues for employers:

  1. Ignoring eligibility guidelines
  2. Not enrolling eligible employees
  3. Delayed deferrals
  4. Late Form 5500 filing
  5. Failing annual compliance testing

After you read this article, you should have a clear picture of what’s required of you to avoid these 5 problems and costly consequences, and feel confident that offering a 401(k) plan to your employees won’t be overly burdensome.

The 5 Common 401(k) Compliance Issues

A 401k plan is a retirement savings plan that allows workers to make pre-tax contributions from their paychecks. That means that workers won’t have to pay taxes on the money they set aside until it’s withdrawn. Many plans also offer a Roth contribution option that lets employees make contributions from the money that’s already been taxed so they don’t pay taxes upon withdrawal.

These features make 401k plans a popular employee benefit. According to SHRM, 93% of employers offer a traditional 401(k). However, while 401(k)s offer significant advantages, they also present compliance problems. Here are 5 of the most common issues employers face.

1. Ignoring Eligibility Guidelines

When you’re designing your 401(k) plan, there are many factors to consider. One of the most important considerations is who will be eligible to participate in your plan.

To reach this determination, you’ll want to consider your business and workforce. For example, if you have a lot of turnover, you probably won’t want to make employees immediately eligible. This can create an unnecessary administrative burden.

The most common approach is to require an employee to complete 12 months of service and be 21 years of age or older before they can enroll. Yet no matter what you decide, you’ll need to document the eligibility criteria in your plan document. Prior to eligibility, the employee must receive the plan’s Summary Plan Description and all forms required to participate.

One common misstep employers make is to ignore the eligibility criteria they set out. So, for instance, a company may allow a new employee to enroll and start contributing to a 401k immediately, and may even make matching contributions, even though the plan documents require a year of service first.

One common misstep employers make is to ignore the eligibility criteria they set out. So, for instance, a company may allow a new employee to enroll and start contributing to a 401k immediately, and may even make matching contributions, even though the plan documents require a year of service first.

In order for the plan to remain in compliance, mistakes like this needs to be corrected. There are different approaches you can take to address the situation, such as making a retroactive amendment to your plan document that applies to the employee. But it’s best to avoid the problem in the first place by making sure anyone at your company involved with plan administration is familiar with the plan terms.

2. Not Enrolling Eligible Employees

When an employee is eligible to participate in your 401(k), you’ll need to provide them the necessary forms to complete like an enrollment form and contribution authorization. Once they submit these forms, it’s your responsibility to ensure they are processed and the employee is properly enrolled. If you don’t, that’s a problem.

For instance, if an eligible employee enrolled in the plan but the chosen deduction is not set up on the payroll system, that constitutes an operational error you’ll need to correct.

If you inadvertently fail to enroll an employee when they were eligible, you can use the IRS’ self-correction program as part of the Employee Plans Compliance Resolution System (EPCRS) and fix the error.

To remain compliant, you’ll want to make sure managers understand who is eligible under the plan and that you review payroll records for hire dates, birth dates, and other information to properly determine eligibility.

3. Delayed Deferrals

With a 401(k), employees can make pre-tax contributions to their plan, called elective deferrals, up to a limit set by the IRS. For 2021, that amount is $19,500, with additional catch-up contributions of up to $6,500 allowed for those over 50. These limits apply to both pre-tax and Roth contributions.

These deferrals should be deposited to the employee’s account as soon as possible, technically on the “earliest date on which such amounts can reasonably be segregated from the employer’s general assets.” However, the deposit should never take place later than the 15th business day of the following month.

A common mistake among employers is to deposit these deferrals late. And that can constitute an operational mistake – which can lead to plan disqualification and a loss of tax-exempt status. The delay can also result in a prohibited transaction because those late deferrals are considered an interest-free loan from the employee to you.

Like correcting eligibility issues, you can use the EPCRS to fix the operational mistake. But, to resolve a prohibited transaction issue, you’ll need to use the DOL’s Voluntary Fiduciary Correction Program.

The best way to avoid these problems is to have a procedure in place that requires employee deferrals to be deposited as soon as possible after the payroll is run, and make sure your personnel understands when these deposits must be made.

4. Late Form 5500 Filing

Form 5500 is used by employers or pension plan administrators to satisfy annual reporting requirements for your 401(k) under ERISA and the Internal Revenue Code. The form requires information about the qualification of the plan, its financial condition, investments, and operations. 

This form is due the last day of the seventh month after the plan year ends (so July 31 for a calendar-year plan or the next business day if July 31 is on a weekend). It must be filed electronically through EFAST2. A Form 5558 can be filed to extend the filing deadline by 2 ½ months but must be filed by the original due date for Form 5500.

While it’s essential to enter the correct information on the form, a frequent issue among companies is filing Form 5500 late, which can result in an IRS penalty of $250 a day up to a maximum of $150,000 and a DOL fine of up to $2,259 a day, with no limit.

While it’s essential to enter the correct information on the form, a frequent issue among companies is filing Form 5500 late, which can result in an IRS penalty of $250 a day up to a maximum of $150,000 and a DOL fine of up to $2,259 a day, with no limit.

If you realize you didn’t file Form 5500, you should do so as soon as possible. The DOL has a Delinquent Filer Voluntary Correction Program which you may be able to use to avoid late filing penalties.

As a best practice, you should establish a process for ensuring the return is filed on time whether you are handling it internally or outsourcing administration to a TPA.

5. Failing Annual Compliance Testing

Each year, you’re required to conduct 401(k) non-discrimination testing under ERISA to make sure your plan isn’t discriminating against lower-income workers in favor of owners or highly compensated employees (HCEs). In 2020, HCEs are those who owned more than 5% of the business or made more than $130,000.

To make this determination, there are a series of annual tests that your plan must undergo. Generally, these are performed by a TPA but you should still be aware of the process even if you’ve outsourced administration of your 401(k). The series of annual tests include: 

  • Actual Deferral Percentage (ADP) Test: This test compares the average deferrals of non-highly compensated employees with the average for HCEs.
  • Actual Contribution Percentage (ACP) Test: This is like the Actual Deferral Percentage Test but includes the employer match contributions and after-tax contributions employees make.
  • Top Heavy Test: This test takes the sum of all key employee balances compared to the total plan balance. Key employees are officers who make over $185,000, employees who own 5% of the company or family member of one, or those who own more than 1% and make over $150,000. If key employees own more than 60% of the value of plan assets, the plan is top-heavy.

While the ADP and ACP tests are the main tests, the top-heavy test is most often a cause for failure. According to the IRS, it’s common for a 401k to be top-heavy, especially smaller plans and plans with high turnover. If you determine your plan is top-heavy, you’ll need to make a minimum contribution to the non-key employees, which is generally 3% of compensation.

To avoid the possibility of failing the discrimination tests, employers can include a safe harbor provision in their plan, which requires the employer to make a mandatory contribution. This can be done either by way of a safe harbor match or safe harbor non-elective contribution (SHNEC).

How to Maintain 401(k) Compliance

We know you may be worried that a 401(k) is too complex and challenging to administer correctly, especially since liability rests with you because of your fiduciary duty. But being aware of common problems like these 5 can help you understand the steps you need to take to meet your requirements and avoid penalties. If taking on the responsibilities yourself seems like it would be too much to handle, you can opt to outsource plan administration to a TPA to take the duties off your plate. If this sounds like an approach you want to consider, you’re probably wondering what it costs to have a TPA handle all the tasks associated with maintaining a compliant 401(k) plan.

To see if this is a viable option for you, read more about what it costs for TPA services



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