A recent IRS 401(k) Phone Forum provided a list of top ten 401(k) plan errors. This list and related comments should give you a good idea of what the IRS looks for and how to avoid common errors.
- Failure to maintain documents. Make sure your original documents and amendments are timely signed and dated.
- Failure to follow the terms of the plan document. Do what the plan document says, not what you hope it says.
- Failure to use the plan’s definition of compensation. 50% of the plans reviewed had a problem with this. It simplifies things when the plan uses one definition of compensation for multiple purposes.
- Failure to follow the plan’s matching contribution provisions. Stay within the plan’s limits.
- Failure to satisfy the ADP and ACP nondiscrimination testing. Problems arise when ownership attribution rules aren’t followed for family members, when employers submit incorrect data to third party administrators, and when incorrect compensation is used.
- Failure to include all eligible employees. This is a common error. Part-time employees are often incorrectly excluded from a plan.
- Failure to limit elective deferrals to the applicable dollar limits for the calendar year. The dollar limits are $16,500 for employees under age 50 and $22,000 for those who have reached it. This error occurs occasionally and is more common when an employee switches jobs during the year and participates in more than one 401(k) plan.
- Failure to timely deposit elective deferrals. This is a frequent problem. Small plans must make deposits no later than the seventh business day after wages are paid.
- Failure to follow the plan’s loan provisions and violation of IRS plan loan rules. This is another very common problem. Some plans make loans without loan provisions in the plan document.
- Failure to follow the plan’s terms regarding hardship distributions. The IRS sees lots of errors in this area.
The IRS also commented on other errors
In addition to the top ten 401(k) errors, the IRS commented on two other common errors:
- Failure to satisfy IRS limits on contributions and benefits. Generally, contributions and forfeitures to an employee’s account in a 401(k) plan can’t exceed the lesser of $49,000 or 100% of compensation. Problems can arise when an employer has multiple plans (which are treated as one plan for this purpose).
- Failure to fully vest employees when a plan is partially terminated. Generally, a partial plan termination occurs when at least 20% of plan participants have been involuntarily terminated over a period of time spanning at least one plan year. These terminated plan participants must become 100% vested and eventually receive their full account balances.
The IRS has a program in place for correcting plan errors. Sometimes errors can be self-corrected. In other instances, such as plan document errors and older significant operational errors, plans may be corrected only through formal filings with the IRS.
Call us if you have any questions.
James A. Derzon, CPA, is the employee benefits specialist for our firm on technical matters pertaining to retirement plans and employee benefits. Jim works in these areas with our clients, large and small. He has extensive experience in both industry and public accounting.