5 Common But Costly Mistakes 401(k) Plans make

January 15, 2013

 401(k) Plans: 5 Common But Costly Mistakes

Studies have revealed that Americans are mostly ill-equipped to face the challenges posed by retirement. IRS section 401(k) plans have become the most popular among all retirement plans in the United States. Today there are more than 60 million employees covered by it. As an employer, you must understand your fiduciary responsibility and carry it out thoughtfully, prudently, and diligently. Call it their ignorance or shirking of their responsibilities, employers across the nation have a propensity to evade the plan. The Internal Revenue Service (IRS) observed a few common, but costly mistakes that company owners made in implementing 401(k) among the staff members. Five of these included: 

1.         The plan document not being kept updated – There is a statutory requirement for the 401(k) plans to be established and supported by printed plan document which conforms to the Internal Revenue Code. Whenever the laws of taxation affecting 401(k) undergo a change, the plan must be updated and adopted within the stipulated deadline.

2.         Failure to follow the plan’s terms or not keeping others informed about any change – It is the fiduciary responsibility of the employer/sponsor to keep the plan consistent with ERISA. There are several employees, tax professionals, and vendors servicing your plan. You have to inform all connected to the operation of the changes.

3.         Not using the plan’s definition of compensation accurately for all allocations and deferrals – As compensation is defined differently for different purposes, it is essential to apply the right definition while dealing with allocations and deferrals.

4.         Failure to make matching contributions to all employees concerned – Often employers do not make the matching contribution that is spelt out in the plan. The timing to contribute may be wrong, or discrepancies may occur due to improper count of timeframe of service, hours worked, misunderstanding of definitions, erroneous following of the terms of the plan, etc.

5.         The plan fails the 401(k) ADP and ACP test for non-discrimination – Employers must ensure that all employees receive their rightful amount of contribution. The non-highly compensated employees (NHCE) must get proportionate contribution as highly compensated employees (HCE).

 If no due care is taken to correct the common, but costly mistakes in time, you are said to be violating federal law. The sooner the mistake is corrected, the lesser degree of possible risks. Company owner cannot get away by feigning ignorance. They have to act in the best interest of the participants of the plan. Besides, it is difficult to hire and retain good workers if the flaws in plan 401(k) are not rectified. The number of participants may fall as also the amount invested in long-term employee retirement plan. IRS will be notified, and a penalty levied on the owner in case he/she shirks fiduciary responsibility.

 It is important to review the requirement for operating the 401(k) plan annually so that it is kept in compliance with all important rules, or else crisis will show up during audits. The definitions of compensation for every deferral and allocation should be used accurately and matching contributions made to all employees under the scheme. Your plan must satisfy nondiscrimination, ADP, ACP tests. Eligible employees must be given the opportunity to opt for elective deferral and the sum deposited to the trust on time. IRC has limited the amount a participant may put into the plan every calendar year. Defaulted loans to participants are taxable. Any hardship distribution must be made in conformity with the plan and your fiduciary responsibility carried out properly.