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Preventing and Fixing Broken 401(k) Plans: 12 Common Compliance Errors

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ED Note: This article is an excerpt from a section in “The Advisor’s Guide to 401(k) Plans” called, “Preventing and Fixing Broken 401(k) Plans.” For the full guide on this and other topics please check out our bookstore.


As we have noted in prior chapters, a qualified 401(k) plan is a defined contribution retirement plan that by its nature will likely run decades. It might be expected to continue beyond current management and maybe even current ownership in the case of family-owned, closely-held companies.

And, as we have discussed, in order to obtain and maintain the desired tax and other qualified plan benefits of a 401(k) plan for the participants (primarily income tax deferral and tax-free growth of earnings) and for the sponsoring company (business expense deduction for employee and employer contributions to the 401(k)), the plan must be properly documented and then operate according to the plan-documented 401(k) design and required legal terms for the life of the plan. That compliance period extends until the plan is officially terminated under the Internal Revenue Code and ERISA requirements.

In summary, the plan must always be in both (1) form and (2) operational compliance, including demographic eligibility compliance, with the terms of the plan document for the life of the 401(k) plan in order to claim the benefits granted to a qualified plan.

Why Comply

As noted, there is the possibility of the 401(k) plan losing its qualified plan status, resulting in immediate taxation of all plan participants as well as the loss of the employer’s business expense deduction for all contributions made to the 401(k) plan. These negative tax consequences are bad enough in themselves for the employer sponsor and the plan participants. However, even worse consequences can occur. As we have already discussed, the sponsor and its designated officials in charge of the plan take on certain personal fiduciary duties and other legal responsibilities with regard to the plan and, with this duty, assume certain legal liabilities if they do not assure proper qualified 401(k) plan compliance.

For example, the DOL has instituted a special program to track down and recover from the fiduciaries on certain plans the employee salary reduction contributions that should have been made to a 401(k) by the employer and were not. The liability for these missed employee contributions (or misdirected and misused contributions due the plan) is not avoided by either corporate or personal bankruptcies. In effect they are like income tax obligations owed; they may not be avoided. Moreover, if there is evidence of intentionality in the actions, even criminal charges may be applied, and have been.

Who Is an ERISA Fiduciary?

According to ERISA, “every employee benefit plan shall be established and maintained pursuant to a written instrument (plan document). Such instrument shall provide for one or more named fiduciaries (emphasis added) who jointly or severally shall have authority to control and manage the operation and administration of the plan.”


[T]he IRS and the DOL have both stepped up audit programs to increase and assure compliance. The IRS is currently—as of the date of this publication—conducting audits based upon the 401(k) questionnaire it has been sending out to plan sponsors and fiduciaries. A nonresponse to the questionnaire will cause an automatic IRS audit on the nonresponder. Otherwise, the IRS is zeroing in on common problems identified by the responses as the focus of its selected compliance program audits. For instance, recently it has been targeting those companies with safe harbor plans that are failing to provide the required annual safe harbor plan notice to participants, as apparently identified from the questionnaire.

And, while many errors offer the opportunity for self-correction under the IRS and DOL correction programs, higher penalties will normally apply if the IRS identifies the problem and takes action on the violation before the plan sponsor. With the advent of the electronic filing of Form 5500, the IRS is likely to discover noncompliance and violations in a plan more quickly than in the past. In this regard, it is valuable to understand the errors and mistakes most commonly made by plan sponsors and fiduciaries with regard to 401(k) plans so that preventative process and procedure measures might be installed from the outset to avoid or reduce the incidence of errors and violations.

Finally, it is unreasonable to assume that such a complex retirement plan with substantial initial and ongoing compliance requirements will never experience an error in its documentation or violation in its operation. In fact, realistic practitioners will say that some errors in connection with qualified 401(k) plans are 100 percent certain to happen given enough time. Fortunately, even the IRS and the DOL have recognized this reality. Therefore, both agencies have adopted extensive programs for the correction of nonegregious qualified plan errors; that is, those made accidentally and without intent to avoid compliance. They have recently even updated and expanded them in Revenue Procedure 2013-12 to make it easier for plan sponsors and their designated officials on the plans to make the necessary corrections.

Common 401(k) Plan Compliance Errors

According to the IRS, the most common errors in connection with qualified plans, and specifically a 401(k) defined contribution plan, are as follows:

  1. Failure to update the required plan document to reflect required mandatory law changes governing 401(k) plans
  2. Failure to follow the terms of the plan document in operation, generally as to those common errors that hereafter follow
  3. Failure to use the SAME plan definition of “compensation” correctly for handling all deferral elections and allocations in the plan
  4. Failure to make employer matching contributions to all the appropriate employees
  5. Failure to apply the 401(k) ADP and ACP nondiscrimination test results to HCE contributions resulting in excess HCE contributions in the plan
  6. Failure to include all the employees in the plan eligible to make a deferral election resulting in lost deferral opportunity (i.e., exclusion of eligible employees)
  7. Failure to limit amounts in the plan under Section 402(g) for a calendar year and failure to make the required distribution of those deferrals ( excess deferrals) that exceeded this limit back to the affected participants
  8. Failure to routinely deposit employee elective deferral amounts on a timely basis
  9. Failure of participant loans to conform to both the requirements of the document and Section 72(p) in operation
  10. Failure to handle financial hardship distributions properly, including cessation of deferrals for the balance of the plan year as required
  11. Failure to make the required minimum employer contributions to the plan when the plan is “top heavy”
  12. Failure to file the required annual Form 5500 return or distribute the annual Summary Plan Description to plan participants


401(k) plans offer substantial tax benefits to both the plan participants and the plan sponsor that are worth protecting. Both the IRS and the DOL have provided corrective programs to cure violations in both documentation and operation of a 401(k) plan. The best approach is to establish a set of internal controls and plan documentation files that support correct documentation and operation from inception to termination of the plan in the distant future. Plan sponsors and plan fiduciaries should acquaint themselves with the most common violations that may occur with their 401(k) plan and establish internal plan controls and procedures to help prevent these violations in the first instance. They may also help surface and identify operational and fiduciary prohibited transaction violations early if they should occur despite the controls and procedures. Use of a knowledgeable and experienced qualified plan administrator can assist in this important process of compliance.

However, with the aid of its legal advisors, the plan sponsor should move quickly to ascertain the best available IRS or DOL program to cure the violation once a documentation or operational violation has been identified. It should then move forward to make the necessary correction under the selected program at the earliest date in order to protect the plan’s income tax benefits for all concerned. And, this action to correct a form or operational error may also protect the fiduciaries and plan sponsor from penalties for any fiduciary failures in connection with the 401(k) plan.


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