401(k) Plan Reviews Help Avoid Compliance Mistakes
While 401(k) plans provide valuable tax-advantaged retirement savings opportunities for employers and employees, they are also subject to extensive legal compliance obligations under the Internal Revenue Code (IRC) and the Employee Retirement Income Security Act (ERISA). These requirements apply both at the plan’s inception and throughout its operation.
To maintain compliance and retain the plan’s tax-qualified status, employers must periodically review and adhere to all applicable rules—at least annually. Failure to do so can lead to plan disqualification, loss of tax benefits, financial penalties, and fiduciary liability.
401(k) Plan Compliance Checklist
Timely Plan Amendments
Update the plan document promptly for:
Statutory and regulatory changes (mandatory updates).
Discretionary amendments (e.g., changes in contribution levels).
Ensure updates are also reflected in:
The Summary Plan Description (SPD).
Or a Summary of Material Modifications (SMM), as appropriate.
Operate the Plan According to Its Terms
Administer the plan precisely as documented.
Deviations may trigger:
Tax penalties.
Breaches of fiduciary duty under ERISA.
Use the Correct Definition of “Compensation”
Ensure the plan’s compensation definition is applied accurately for:
Contribution allocations.
Required nondiscrimination testing under the IRC.
Retirement Plan Sponsors: Your Essential Responsibilities Explained
Comply With Applicable Contribution Nondiscrimination Tests.
401(k) plans are subject to special nondiscrimination tests applicable to elective salary deferrals (pre-tax and Roth contributions) on the one hand and to matching contributions and employee after-tax contributions on the other. These tests generally limit the contribution amounts allocated to higher-paid participants. Failure to promptly correct noncompliance with these nondiscrimination tests can result in additional tax penalties for the employer.
Ensure all Eligible Employees Have the Opportunity to Participate in the Plan.
Improperly excluding eligible employees from the 401(k) plan may result in “corrective additional contributions” made by the employer to the plan.
Ensure Elective Salary Deferral Contributions do not Exceed the Annual Limit.
Elective salary deferral contributions under all 401(k) plans are subject to an IRS-prescribed annual calendar year limit. For 2019, the dollar limit for elective salary deferrals to all 401(k) plans is $19,000. For participants aged 50 or older during 2019, the dollar limit for “catch-up” elective salary deferrals is an additional $6,000 (if the plan otherwise permits such catch-up contributions). These dollar limits are subject to annual adjustments by the IRS based on changes in the “cost of living.”
Ensure Plan Loans are Property Administered.
While participants may borrow from their account under a 401(k) plan (if the plan permits loans), if such loans do not comply with legal requirements or are not timely repaid, the amount of such loan will be taxable to the participant.
Ensure “Hardship” Distributions are Properly Administered.
401(k) plans may allow participants to receive a distribution while employed if they have an “immediate and heavy” financial need that generally cannot be met from other available financial sources. Hardship distributions must be made in accordance with legally compliant plan terms and procedures. The regulatory rules for hardship distributions were recently revised and liberalized by the IRS.
Is a “Top-Heavy” Plan Minimum Contribution Required?
Suppose a 401(k) plan is a “top-heavy” plan (i.e., account balances for “key employees” exceed 60% of account balances for all participants). In that case, the plan will be subject to a minimum contribution requirement for all “non-key employees.” Top-heavy plan status is generally more common among small employer plans.
Timely Form 5500 Annual Reporting Requirement.
401(k) plans must file annual information returns (Form 5500 Reports) with the U.S. Department of Labor. The type of Form 5500 report and the scope of the report information required depends generally on the plan size (e.g., plans with 100 or more participants typically must include an independent plan auditor report with the Form 5500 filing). Failure to file Form 5500 reports promptly (generally by the end of the seventh month following the plan year’s end unless such filing due date is extended) can result in significant late filing penalties.
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