Compliance is essential when offering a 401(k) plan

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Offering a retirement plan is a great way to show your employees you care about their future and want to compensate them well. Employees care about retirement benefits, and some states now even require employers to offer some way to save for retirement. However, offering a plan isn't exactly as simple as just snapping your fingers. There are many compliance considerations to take into account as you research and consider what plan might be right for your organization.

Although 401(k) compliance can be complicated, it does matter at the end of the day. If your company offers — or is considering offering — a 401(k) plan, you're likely familiar with the importance of compliance.

Staying compliant with the many rules and regulations set forth by the Department of Labor (DOL), Internal Revenue Service (IRS), and your plan documents will help keep your plan legal and fair for all your employees.

401(k) plans offer a big tax benefit, so the IRS cares if the plan isn't compliant. If your plan isn't compliant, that could put its tax-qualified status in jeopardy. In this guide, we will do a deep dive into the most common 401(k) compliance mistakes so you can understand how to avoid penalties and continue offering a compliant plan with more peace of mind.

What is compliance testing?

Compliance testing is a series of tests that 401(k) plans must go through to prove that they are complying with IRS requirements. Compliance testing helps confirm that plans don't disproportionately favor certain employees, like business owners and high earners, and that employees don't contribute more than they are allowed. Now, exactly which tests are required? That'll depend on the specific design of your plan.

Compliance testing includes limits testing and nondiscrimination testing. There are three common nondiscrimination tests: the top heavy test, the actual deferral percentage (ADP) test, and the actual contribution percentage (ACP) test (Note: more tests could apply depending on your plan design.)

Unfortunately, companies fail these tests more often than you might think. In fact, according to one study1, 45% of plans were considered Top Heavy, 27% of plans failed the ADP test, and 4% of plans failed the ACP test.2

The consequences of failing compliance testing

While it won’t be the end of the world if you fail a compliance test, it can take some time, money, and effort to fix. A common fix is making corrective distributions or contributions. But if you don’t catch a mistake in time, you may be subject to penalties, plan disqualification, and associated tax consequences.

Watch out for other common compliance problems

While compliance tests are a major hurdle to pass, there are other mistakes that can lead to costly compliance problems as well. These include making administrative mistakes, missing out on legislative changes, failing to update your plan documents, submitting filings late, or making mistakes when enrolling new participants.

In this guide, we'll cover the top 12 most common compliance mistakes and (more importantly) how to avoid them. That way you can focus on offering a robust retirement benefit while keeping your plan safe and compliant.

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Disclosures:

This information is for informational purposes only. It should not be considered tax and/or legal advice. Please consult with a Tax Professional or Accountant before applying the content herein.

1 Source: Employee Fiduciary. (2024, January 9). 401(k) Nondiscrimination Testing Study – What % of Plans Fail? https://www.employeefiduciary.com/blog/401k-nondiscrimination-testing-study

2 Excludes Safe Harbor plans