Quality employee benefits are essential to attracting and retaining top talent. Effectively operating all the benefit offerings is time-consuming and requires expertise across various programs. It may be difficult for small businesses to invest the necessary time and resources into managing their 401(k) plans correctly. Even the most well-intentioned employers can make costly mistakes regarding their 401(k) plans. These mistakes can be time intensive, expensive, and, in some cases, threaten the plan’s tax-favored status. 

This blog discusses four of the costliest 401(k) plan mistakes employers often make and how to avoid them.

1. Untimely Remittance of Elective Deferrals

Employee deferrals are contributions employees elect to put into their retirement accounts from each paycheck. As an employer, you are responsible for remitting employee deferrals to the retirement plan at the earliest date those assets can be segregated from the general payroll amounts. For plans with fewer than 100 eligible participants, the Department of Labor (DOL) provides a safe harbor rule that gives employers seven business days to make the deposit. Larger plans are expected to remit the funds within seven business days.

If you fail to remit these employee deferrals on time, you are required to file a correction. The IRS correction program allows employers to fix errors in their employee benefit plans by depositing all delayed deferrals plus the lost earnings from the late deposit. In addition, the employer may have to pay a 15% tax on the lost earnings and file a Form 5330 Return of Excise Taxes to complete the correction.

2. Incorrect Use of Eligible Compensation

Eligible compensation is the defined compensation items that are used to calculate employee elective deferrals and employer-matching contributions. Each plan document will have a unique definition of eligible compensation. For example, a plan may define eligible compensation as W-2 compensation but specifically exclude bonuses.

Following the wrong definition of eligible compensation may lead to overstated or understated elective deferral and matching contributions. The corrective action needed depends on whether the contributions were overstated or understated.

To avoid this mistake, companies should review all pay codes in their system to ensure elective deferrals are turned on or off, depending on the plan's definition of compensation. In addition, companies should consider simplifying their definition of compensation.

3. Inconsistent Application of Eligibility Requirements

Employee benefit plans usually have a few key eligibility requirements employees must meet before they can participate. The most common requirement is typically related to an employee's length of service with the company. For example, you may require employees to work for your company for at least 30 days before they are eligible to participate in the plan.

To avoid an eligibility issue, companies should provide proper training to new hires, guiding them on when they can participate and how. Additional notices should be sent to the employees when they become eligible to encourage employees to participate in the plan.

If a participant is not given the opportunity to participate after the eligibility requirements are met, a corrective contribution may be required to make up for the missed deferral opportunity. Companies should consider implementing an automatic contribution feature to reduce the risk of missed deferral opportunities.

4. Failed Compliance Measures

Employers have a variety of compliance measures needed to administer a plan properly. These measures include filing a form 5500 with the DOL and passing annual compliance testing. A Third-Party Administrator (TPA) is generally involved in helping business owners stay compliant in their administration duties.

Employers are required to file Form 5500 every year with the DOL. TPA's often assist in preparing the filing. This form contains information about your company's 401(k) plan and needs to be filed seven months after the plan year-end. If you anticipate a delay, you can request an extension of the deadline for two and a half months. You may be subject to penalties if you miss the deadline, but you can find some relief with the Delinquent Filer Voluntary Compliance Program.

The TPA will perform annual compliance tests, including limits testing, to ensure no participant exceeds the contribution limits set by law. They will also perform nondiscrimination testing to ensure the plan does not favor highly compensated employees. If you fail any of these compliance tests, corrective actions will be given by the TPA. These corrective measures are generally required within two and half months after the plan year-end.

Employee benefit plans are an effective way to attract and retain top talent. However, these plans can also be confusing and costly. The above tips will help companies administer their plans effectively and efficiently while ensuring employees receive the appropriate benefits. At Lutz, we are passionate about creating solutions to help your business succeed. Contact us to learn more.