IRS 401k Fix-It Guide: A Primer On How to Fix Your 401(k)
Have you ever discovered an error in your small business 401(k)? If so, then you probably remember that same sudden feeling of panic as when you’ve misplaced your smartphone, or discovered your flight leaves an hour earlier than anticipated. Except amplified, as you speculate the impact on your colleagues’ savings in retirement.
The IRS understands your panic and has compiled a document with a dozen common mistakes and tips on how to avoid them. Descriptively titled the “401(k) Plan Fix-It Guide”, you can think of it as a 12-step plan for running a compliant 401(k).
The IRS’s 401(k) Fix-It guide is helpful but extremely dense, so we’ve presented an abbreviated version below to try to make it a bit easier to digest. We try to describe the essentials to remember in a way that doesn’t require a law degree to understand.
Check out our Reader’s Digest version of the IRS “401(k) Plan Fix-It Guide” below! In the name of transparency, it doesn’t cover everything you need to know about managing your plan, but is a great resource if you’re concerned about compliance or wondering how to address a specific error. Without further adieu, here are our IRS Fix-It Guide notes presented as a twelve-row table:
|Mistake||How to Diagnosis||How to Fix||How to Avoid|
|1.||Plan document not updated||Review current regulations to ensure plan documents comply.||Adopt amendments for missed law changes.||Schedule amendment updates. Review plan document regularly|
|2.||Plan operations conflict with plan document.||Review plan to compare provisions with operations.||Make corrections such that participants are no worse off.||Adopt process to communicate plan changes. Check adherence with annual review.|
|3.||Proper definition of compensation not used in deferrals and allocations||Review document for definitions and stipulations regarding contributions.||Make corrective contributions, reallocations or distributions.||Annually, review compensation definitions.|
|4.||Matching contributions not made to all appropriate employees.||Compare eligibility as defined in document to actual contributions.||Apply a reasonable correction method.||Make sure those making contributions have accurate payroll data.|
|5.||Plan failed ADP and ACP tests.||Determine if employees are classified correctly.||Make qualified non-elective contributions for the non-highly compensated.||Consider a safe harbor plan design or adopt automatic enrollment.|
|6.||Eligible employees not given the chance to make a deferral.||Review plan’s sections on eligibility and check to see when employees are entering the plan.||Make a qualified non-elective contribution to compensate for the missed opportunity.||Monitor census information and apply participation requirements.|
|7.||Elective deferrals weren’t limited under 402(g) and excess deferrals weren’t distributed.||Inspect deferrals to ensure employees have not exceeded limits.||Distribute excess deferrals.||Make sure administrators have enough information to verify 402(g) deferral limitations.|
|8.||Employee deferrals not deposited on timely basis.||Determine the earliest date deferrals can be segregated from general assets. Compare with actual deposit date.||Usually corrected through DOL’s Voluntary Fiduciary Correction Program.||Set up procedures to ensure timely deposits.|
|9.||Participant loans don’t conform to regulations.||Review loans to see if in compliance.||Some corrections may be made with loan modifications||Review each loan and evaluate loan procedures.|
|10.||Hardship distributions not properly made.||Review hardship distributions for compliance.||Amend plan to retroactively allow for hardship distributions. Otherwise have participant return distribution.||Understand hardship distribution provisions.|
|11.||Plan was top-heavy and required minimum contributions not made.||Review top-heavy definitions for plan and evaluate plan’s status.||Contribute and allocate required top-heavy minimum.||Perform top-heavy test annually.|
|12.||You failed to file a Form 5500 this year.||Find the signed copy and determine if it was in fact filed.||File all delinquent returns.||Understand the filing requirements and know when it is filed.|
|Source: IRS 401(k) Fix-It Guide|
Drilling down into the Fix-It Guide
Although the Guide does a good job of outlining potential mistakes, a few items may need a little further explanation.
Take #3, the definition of plan compensation. Your plan may use different definitions of compensation for different purposes. If that’s the case, it’s important to apply the proper definition to deferrals, allocations, and testing. For example, your plan may call for excluding overtime when calculating an employee’s monthly contribution. If so, then that’s how the deferral should be calculated. But when it comes to testing, the ADP test may require that overtime be included in the calculation. So the appropriate definition of compensation must be used in the appropriate circumstance. And of course, the maximum salary for calculating employer matching contributions must not be exceeded. For 2018 the amount is $275,000. If the company is matching at a 4% rate and an employee is making $300,000, the company’s contribution would be limited to 4% x $275,000 or $11,000.
The Guide’s #7 may call for a closer look if you don’t have instant recall of Section 402(g). But #7 simply means that the plan doesn’t allow an employee to contribute more than the $18,500 maximum (for those younger than 50). If that mistake is made, the excess contribution should be returned to the employee. While the IRS calls this a distribution, there is no 10% distribution tax associated with the return of the funds as would be the case if an employee intentionally withdrew funds prior to age 59 ½.
If your 401(k) plan allows participant loans, #9 is a reminder to follow IRS guidelines. For example, did you know that the amount of a 401(k) loan can be no more than 50% of a participant’s vested account balance? And that the total outstanding loan balance can be no more $50,000?
These are just a few examples, but if you have more questions feel free to get in touch and ask us anytime! We’re always happy to delve deeper.
Beyond the Fix-It Guide: Preventing and fixing 401(k) mistakes on an ongoing basis
You may have noticed that the Guide has similar recommendations when it comes to preventing mistakes: tighter communication between parties, lots of document review, and regular testing. But most small business plan administrators have too much on their plate, and unfortunately the Guide doesn’t recommend how to find time to run your actual business.
It’s best practice to have an independent third party periodically conduct a comprehensive plan review to identify potential errors, and many sponsors go a step further and elect to hire an expert to take on the administrative work and liability. This is a great move so long as you make sure to hire a fiduciary with 401(k) expertise like ForUsAll, not just any private wealth advisor who may not have your employees’ best interest in mind.
ForUsAll is a one-stop shop designed specifically to fix small-business 401(k) plans and help sponsors outsource their administrative burden. Because ForUsAll handles all aspects of plan administration for the employer, we can reduce errors that trip up many small businesses managing the 401(k) on their own. Plan administration is the core of our advisory practice, and we leverage cutting-edge software to automate many aspects including deferrals, investment elections, employee eligibility and mandatory onboarding communications. And we run over 30 compliance checks each payroll cycle. By providing 3(16) fiduciary services, we relieve our clients of much of the liability associated with running a great 401(k) plan.
We also know there is more to running a 401(k) than avoiding mistakes. In addition to seeking a mistake-free plan, it’s important to have a healthy 401(k). By healthy, we mean that the plan is working for both you and your employees. That means that most employees are in the plan, are contributing to the plan, and are understanding the plan. Even better, employees understand how much they need to save to fund a successful retirement nest egg.
At ForUsAll, our average plan is a picture of health. Participation rates are around 89%, even higher than that experienced by much larger companies (as published in The 58th annual PSCA survey). And that’s not all – employee education and easy-to-access technology have delivered an average deferral rate of 6.8%. That is a full percent higher than the rate achieved by much larger plans with an average $1.3 billion in assets. We think this is a big deal! A healthy retirement plan means your company is offering a great benefit that is being used.
Getting more employees to join the 401(k) plan and save at high rates helps to keep your plan compliant and pass the annual IRS nondiscrimination tests. And that means less chance of making mistakes #5 or #11.
And with fewer things to fix, there’s more time for you to run your actual business. That increases the odds of your company remaining financially healthy.
If you want to focus more time on running your business and delegate more of the duties associated with your firm’s 401(k), schedule a time to talk with ForUsAll today. We can start with a free plan health assessment, which is essentially a more in-depth, tailored, and interactive alternative to the IRS Fix-It Guide.