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5 mistakes that will put your 401(k) plan at risk

5 mistakes that will put your 401(k) plan at risk

July 18, 2023

Though establishing a retirement plan can attract and retain talent, employers must be cautious of potential pitfalls such as substantial penalties, plan audits, or even complete plan disqualifications. In this article, we will delve into five common mistakes that could put your plan at risk.

Risk 1: The plan is not in compliance with 404c

ERISA is a federal law that establishes the standards for private pension plans such as 401(k) where section 404(c) is a specific part of this law that allows employees to direct the investment of their own retirement accounts. However, If employers are non-compliance with 404(c), it can create issues for their retirement plans. To avoid trouble, ensure your plan complies with 404(c) as it protects employers from potential litigation due to participant-directed investments.

A 404c retirement plan should feature the following:

  1. It should enable participants or beneficiaries to manage assets in their individual accounts.
  2. It should offer participants or beneficiaries a selection of at least three investment options, each exhibiting distinctly different risk and return profiles.

Risk 2: Insufficient Fidelity Bond

An ERISA Fidelity bond guards the plan against losses from fraud or dishonesty by individuals handling funds (like plan officials or administrators). Each official must have a bond covering at least 10% of the handled funds, with a minimum bond of $1,000 per plan. Non-compliance with fidelity bond requirements can:

  1. Trigger a plan audit, as ERISA law requires plan officials to hold an ERISA Fidelity Bond.
  2. Hold plan fiduciaries personally accountable for any losses of plan assets.


Risk 3: Employee’s elective deferrals are not timely deposited to their accounts

The DOL dictates employers must deposit deferrals promptly, but no later than the 15th business day of the following month. A 7-day safe harbor applies for plans with less than 100 participants. There's a 20% penalty for untimely 401(k) deposits. Employers must also cover lost earnings from the deposit due date until the actual deposit date. A recurring 15% IRS tax applies on these unpaid earnings, paid via Form 5330. If unpaid within the due year, the tax recurs annually until the mistake is rectified. There are a couple of ways to avoid such mistake:

  1. Set a procedure to deposit elective deferrals aligned with each payroll. Document reasons for any late deposits due to disruptions.
  2. Work with your payroll provider to set the earliest reasonable deferral deposit date, in accordance with your plan document.
  3. Instill practices and educate new personnel on deposit timelines to ensure consistency.


Risk 4: The plan failed the 401(k) ADP and ACP nondiscrimination tests.

Each year, 401(k) plan sponsors must ensure contributions from regular employees (NHCEs) proportionally match those of owners/managers (HCEs). HCEs can defer more as NHCEs save more. These checks, called ADP and ACP tests, must be passed, or corrective action should be taken within the statutory correction period.

Plans have 2.5 months post-plan year to correct excess contributions, which can be distributed anytime within 12 months. Failure to correct within this period can lead to the loss of the plan's tax-qualified status.

There are many ways to avoid failing of nondiscrimination test but in summary, you should ensure that you're familiar with your plan’s terms, and provide your plan administrator with the information needed to make a proper determination of each employee’s status.


Risk 5: You haven’t filed a form 5500-series return this year

ERISA and the Internal Revenue Code mandate that many employers and plan administrators submit reports and provide plan information. Most 401(k) sponsors must annually file Form 5500, facing significant penalties for lateness. IRS charges $25/day (max $15,000) for late filings, increasing to $250/day (max $150,000) for post-2019 filings. DOL penalty for late filing is up to $2,529/day with no maximum. Here are some ways to avoid such mistake:

  1. Recognize your duty as a plan administrator to ensure timely return filing. Don't assume others will do it for you.
  2. Assign a person or hire an external service provider to file the return on time.
  3. Utilize a calendar noting the return filing deadline and set reminders for the administrator and service providers.