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Tips for conducting a year-end 401(k) plan review

Lori Jones October 4, 2019

A version of this article previously appeared in the Autumn 2019 issue of Employee Relations Law Journal.

According to the Internal Revenue Service (IRS), the best way for an employer to avoid 401(k) plan mistakes is to conduct an annual checkup of the plan document and plan operations. The IRS provides a 401(k) plan checklist on its website for this purpose.[1] The checklist identifies the following 11 areas that should be included in a 401(k) plan review, as well as tips for avoiding mistakes in each area.

Timely update the plan document

Section 401(k) plans must be timely amended to reflect changes required by law, referred to as interim amendments, and plan changes not required by law, referred to as discretionary amendments. The deadline for interim amendments depends on whether the 401(k) plan document is pre-approved by the IRS, i.e., a prototype or volume submitter plan document, or a plan document that is individually designed for the employer. An interim amendment to a pre-approved 401(k) plan document must be adopted by the later of (i) the due date (including extensions) for filing the income tax return for the employer’s tax year that includes the effective date of the amendment, or (ii) the last day of the plan year that includes such effective date. An individually designed plan must adopt an interim amendment by the last day of the second calendar year following the year the required amendment appears on the Required Amendments List published by the IRS.[2] Both pre-approved and individually designed plans must adopt a discretionary amendment by the end of the plan year in which the amendment becomes effective.

To comply with this requirement, the IRS recommends that an employer identify an employee who is responsible for (i) contacting plan service providers to determine whether a plan amendment is required by the end of the plan year and (ii) determining whether any discretionary plan amendments are being proposed. Ideally, this process will begin no later than the end of the third quarter of the plan year. If an amendment is needed, a tickler file should be established to ensure that the amendment is drafted, reviewed and adopted in a timely manner. The employer should maintain signed and dated copies of all amendments and provide copies to all plan service providers. It is good practice to also update the summary plan description and other plan communications at this time.

Operate the plan in accordance with the plan document

The requirement to operate a plan in accordance with the plan document is both a condition for qualified plan status under the Internal Revenue Code and a fiduciary obligation under the Employee Retirement Income Security Act of 1974, as amended (ERISA). These types of mistakes can occur if changes are made to a plan document or plan operations and the necessary parties have not been apprised of such changes. Mistakes can also occur if there is staff turnover, a change in a plan service provider or a change in the controlled group of the employer. The IRS recommends that plan administrator develop a standard procedure for communicating plan document and operational changes to staff and plan service providers. This communication should include mergers, acquisitions or divestitures that may impact the employer’s controlled group.

Use the correct definition of compensation for deferral contributions and allocation of employer contributions

An employer may use different definitions of compensation for various legal requirements. For example, compensation for purposes of income tax withholding is different than compensation used for employment tax withholding. The 401(k) plan document may provide yet another definition of compensation for determining plan contributions.

Mistakes can be avoided by training employees who are responsible for calculating contributions or preparing data files for plan service providers. It is critical that these employees know the definition of compensation in the plan document and be informed of any changes to such definition. It is also important that plan service providers have the current plan document, including amendments. If possible, simplify administration by using the same compensation definition that is used for other legal obligations, e.g., the definition of wages for income tax withholding. Finally, identify the respective roles and responsibilities of employees and plan service providers in calculating plan contributions to ensure seamless plan operations. Employers should always keep signed copies of their service agreements in case issues arise.

Ensure that matching contributions are provided to all eligible participants

As with the definition of compensation, it is important that employees and plan service providers know the plan provisions with respect to matching contributions and have sufficient employment and payroll information to identify employees eligible for matching contributions and calculate such contributions. This is another area in which it is essential for all parties to understand their relative responsibilities under the plan.

Properly complete ADP and ACP nondiscrimination tests

Section 401(k) plans are subject to the actual deferral percentage (ADP) test, which compares the elective deferrals of highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). Plans must distribute or otherwise correct excess deferrals by HCEs. Similarly, the actual contribution percentage (ACP) test compares the matching contributions made for HCEs and NHCEs and requires correction of excess contributions made behalf of HCEs.

Mistakes in nondiscrimination testing can be avoided by careful and complete sharing of information between the employer and third party service providers. For example, the employer must communicate any changes in its controlled group that could affect both the employees eligible to participate in the 401(k) plan and the employees that must be counted in the nondiscrimination testing. Both the employer and the plan service providers need to know how the plan treats employees of acquired entities.

Other information that should be reviewed for accuracy include compensation data and data needed to identify HCEs. Both the employer and plan service providers should carefully review the list NHCEs for changes in the level of compensation in the prior year.

Ensure that eligible employees have the opportunity to make deferral elections

For some 401(k) plans, eligibility to make deferral elections may depend on birth dates, hire dates, and hours worked. Many plan service providers rely on the data provided by the employer in administering eligibility provisions. Therefore, employees involved in plan operations must know the eligibility rules and gather the information necessary to determine an employee’s eligibility to make deferral elections. It is advisable to compare payroll records with information reported on federal and state tax forms to ensure accuracy.

Limit elective deferrals as required by applicable law

For 2019, the general dollar limit on elective deferrals to a 401(k) plan is $19,000.[3] For participants who are age 50 or older during 2019, the limit increases to $25,000.[4] Mistakes in this area can be avoided by making sure that plan service providers have the payroll information necessary to verify compliance with the limit and apply safeguards that stop deferrals when the limit is reached. Both employers and plan service providers should have backup procedures for detecting excess deferrals so that timely correction can be made, if necessary.

Timely deposit elective deferrals

Late deposits of elective deferrals constitute a prohibited transaction by plan fiduciaries. Department of Labor (DOL) regulations require that an employer deposit elective deferrals into the plan as soon as practicable, but not later than the 15th business day of the following month.[5] However, the DOL does not consider the 15th business day rule to be a safe harbor.[6] Thus, the DOL may impose penalties on employers who delay deposits in accordance with the 15th business day rule.

To avoid penalties for late deposits, the payroll department or payroll provider must coordinate with the plan trustee and other plan service providers to make deposits on the earliest possible date. Noncompliance sometimes occurs are a result of turnover in staff or plan service providers. New staff, particularly payroll personnel, must be trained regarding deposit practices and the need to make timely deposits of elective deferrals. In the event a deposit is delayed, it is advisable to document the circumstances in the plan file.

Ensure that participant loans and hardship distributions comply with the plan and applicable law

Loans to a participant from a plan constitute a prohibited transaction unless the requirements of the Internal Revenue Code and related regulations are met. The regulations impose limits on loan amounts and dictate loan terms, including the loan term, the loan amortization schedule, and the interest rate.

The employer should develop a loan policy that outlines procedures, such as loan defaults, and ensure that the policy is communicated to payroll personnel involved in plan administration and plan service providers. To avoid mistakes both the employer and plan service providers should maintain records to monitor the number of outstanding loans per participant, the permissible loan amount and loan repayments. In addition, the employer and service providers should regularly review reports (monthly or quarterly) on outstanding loans, including loans in, or at risk of, default. Periodically, the employer and plan service providers should review plan loan forms to ensure compliance with applicable law.

Similar steps should be taken to avoid the improper issuance of hardship distributions, i.e., the development and communication of a hardship distribution policy that complies with the plan provisions and applicable law, and review of regular reports with respect to hardship distributions. In particular, an employer should monitor the number of hardship distributions permitted under the plan to identify possible abuse of this plan feature.

Make top-heavy minimum contributions, if applicable

A top-heavy plan is a plan in which the total value of the plan accounts of key employees[7] is more than 60% of the total value of all plan accounts as of the last day of the prior plan year. Most plans do not meet this definition. The issue is more relevant to smaller plans that cover owners of the employer. If a plan is top-heavy, the employer must contribute up to 3% of compensation to the plan for all non-key employees employed on the last day of the plan year.

Plan administrators should perform a top-heavy test annually and ensure that plan service providers have relevant information regarding ownership interests held by employees.

Timely file a Form 5500 for the plan

The Form 5500 is required annually for 401(k) plans. Significant penalties are imposed for a late filing or failure to file. Filing failures sometimes arises in connection with a merger or acquisition or when there is staff turnover.

The responsibility for the Form 5500 filing should be assigned to a single employee. This is true even if a plan service provider will prepare the actual Form 5500 because the ultimate responsibility for the filing rests with the employer and the plan administrator. A tickler system should be used to ensure that data can be gathered and communicated to Form 5500 preparer in a timely fashion.


The above checklist likely reflects the mistakes most commonly uncovered by the IRS in a plan audit. Should employers discover irregularities during a 401(k) plan checkup, the IRS website provides helpful tips on plan corrections.[8] In some cases, self-correction is possible with the assistance of legal counsel and no direct involvement by the IRS. In the case of more significant mistakes, it will be necessary to file an application with the IRS under its voluntary compliance program. In the case of a late Form 5500 filing , the DOL maintains a Delinquent Filer Voluntary Correction Program whereby plan administrators can voluntarily report the failure and pay significantly lower penalties.

Lori Jones is the chair of Thompson Coburn’s Employee Benefits practice.

[1] https://www.irs.gov/pub/irs-pdf/p4531.pdf

[2] The Required Amendments List is an annual list of changes in the requirements applicable to qualified retirement plans and the deadlines for such amendments. The Required Amendment List for 2018 is found in Notice 2018-91, 2018-50 I.R.B. 985 (December 10, 2018) and did not include any changes in qualification requirements due to the lack of statutory or regulatory guidance.

[3] Notice 2018-83, I.R.B. 2018-47 774 (Nov. 19, 2018)

[4] Id.

[5] DOL Regulation §2510.3-102.

[6] There is a 7-business day safe harbor for plans with less than 100 participants. DOL Regulation §2510.3-102(a)(2).

[7] A key employee is defined as (i) an officer making over $180,000 for 2019, a 5% owner of the employer, or (iii) an employee owning more than 1% of the employer and making over $150,000 for the plan year. IRC §415(i)

[8] https://www.irs.gov/pub/irs-tege/401k_mistakes.pdf