How to Avoid Common 401(k) Administration Issues
posted by Alex Queen April 22, 2019
The Employee Retirement Income Security Act (ERISA)—the federal law that governs 401(k)s and other private-sector retirement plans—is lengthy and complex. But you can keep your 401(k) plan on the right track by following this 401(k) administration guide to avoid the seven most common administrative issues.
1. Follow the terms of your 401(k) plan document
What is a 401(k) plan document? A 401(k) plan document is a governing document that outlines the specific rules and features of your plan—including eligibility requirements, allowable contributions and vesting schedules. Under ERISA, you have a fiduciary duty to operate your plan in line with your plan document.
Sometimes that’s easier said than done. Plan documents are generally long and contain a lot of legalese, or what I sometimes call ERISA-speak. And, when you’re busy, it may seem easier to take administrative actions without checking your plan document.
But it’s best not to guess. Avoid 401(k) problems by getting your service provider to clarify the legal language in your plan document to be sure your operations are consistent with the document.
2. Update your plan document to reflect new rules
The laws affecting retirement plans can and do change from time to time. If you offer your employees a 401(k) plan, you’re required to promptly update your plan document to reflect recent legislative changes. In 2018, for instance, Congress passed a budget law that changed some of the rules related to hardship distributions from 401(k) plans. The changes went into effect in 2019. If you haven’t done so already, ask your service provider to change your plan document to reflect the new rules.
In some cases, it’s possible to adopt written amendments to your plan. In other cases, it may be necessary to rewrite the plan (a process known as “restating” the plan).
Plan documents are typically updated at least every five years to keep them current with regulations. But a lot can change during a five-year period—which is why it’s important to ask your service provider to help you take a proactive approach to updating your plan document. This is why we make it a practice to review our client’s plan documents annually.
3. Apply your plan’s definition of employee compensation to all contributions
How you define compensation in your 401(k) plan document is very important. For example, how to treat year-end bonuses, fringe benefits and other forms of irregular compensation are some of the biggest sources of confusion. Unfortunately, many plan documents contain confusing or incomplete definitions of eligible compensation. That’s especially true for 401(k) plans that haven’t been reviewed or revised in several years. Often, such plans have nuanced definitions of compensation that are hard for payroll providers or recordkeepers to administer.
It’s important to correctly use the plan definition of compensation to avoid missed savings opportunities (discussed below) and/or ineligible contributions to your plan. Ineligible contributions may have tax consequences for the affected employees.
When in doubt, work with your 401(k) provider to determine whether you are using the correct definition of compensation for deferrals and allocations.
4. Make timely 401(k) payroll contributions
You can help participants stay on track by making payroll contributions to 401(k) providers on time. Your service provider may be helpful with this effort so participants don’t miss opportunities to save.
Missed savings opportunities deprive 401(k) plan participants of the chance to contribute to their accounts in a timely way. A missed savings opportunity might be a one-time occurrence, or the issue may persist for months, if not years.
From time to time, my team has stepped in to help clients who weren’t making timely payroll contributions. In these situations, we coordinated with recordkeepers to help clients get back on track by making sure they got regular reminders to make payroll contributions and, in some cases, training for the clients’ employees. The article 5 Ways to Manage Employee Payroll Information for 401(k) Plans, provides an overview of 401(k) payroll options and is well worth a look if your method doesn’t fit your needs.
5. Follow deadlines for corrective distributions
The IRS requires annual tests for many 401(k) plan types to check that the benefits of your plan are shared broadly among your employees. Most sponsors hire a 401(k) plan service provider to complete these compliance tests, and it’s not uncommon for plans to fail the tests.
Failing compliance testing isn’t necessarily a bad thing: If your plan fails its yearly Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, that’s usually a sign that most employees, outside of your top employees, didn’t save enough in the plan.
Read my 3 Tips for Surviving Compliance Testing Season for a more in-depth dive into this topic.
To avoid having to take these measures in the future, you may want to consider a safe harbor 401(k) plan—a type of 401(k) with an employer match that allows you to avoid most annual compliance tests.
6. Distribute notices and disclosures in a timely manner
You have a fiduciary duty to distribute certain materials and disclosures to newly eligible employees and existing participants. The goal here, as per ERISA, is to provide employees with the information they need to make timely and informed decisions about their 401(k) accounts.
The good news is that someone else (either the TPA or recordkeeper) puts together the materials for you to distribute. And if you have a 3(16) plan administrator, they'll take care of the distribution step too.
7. Know your plan’s rules for distributions and loans, and stick to them
Participants are often tempted to dip into their 401(k) savings for all sorts of reasons, from funding home improvements to handling unforeseen expenses. That’s why it’s important to understand what your business has determined they can do under the terms of your plan document.
Each 401(k) plan has specific rules surrounding distributions (including hardship distributions) and loans. For instance, your plan may have limits on how many loans an individual participant may take and how much they may borrow.
As someone who manages a company 401(k), you may want to ask your service provider to explain your specific distribution rules. I work with clients to help clarify the duties and ongoing maintenance of distributions and loans so they don’t have to go through the trouble.
Take Action to Get Back on Track
There are many reasons to try to avoid missteps. Misstep penalties can include fines and, in extreme cases, plan disqualification. When a 401(k) plan is disqualified—in other words, loses its federal tax-exempt status—participants may owe income taxes on some of their investments.
By following these guidelines, you’re more likely to keep your plan on track. But if you overlook something, or make a mistake, don’t panic. There are many established ways to fix and avoid common missteps. The Internal Revenue Service’s Plan Fix-It Guide outlines many of these corrective actions.
It’s important to act quickly to address any issues. The sooner you find and fix an issue, the less impact it’s likely to have on your company and plan participants.