Quick Takeaways

• Missing or outdated plan documents are a leading audit red flag.
• Late contributions can result in compliance violations and penalties.
• Incorrect compensation definitions often cause misallocated contributions.
• Failure to enroll eligible employees leads to costly corrective contributions.
• Proactive planning and strong partnerships with TPAs and payroll providers can mitigate these risks.

First off--when is an audit needed?

Check out our blog, When does a 401k Plan Need an Audit? While these audits are critical for compliance and transparency, they often reveal common issues that can catch plan sponsors off guard.

Why is the Plan Document/Adoption Agreement important?

Plan participants are entitled to receive certain documents when they become eligible to participate in a plan. One of which is the Plan Document or Adoption Agreement. These documents are legal and binding documents that inform participants of what the plan provides and how it operates. They provide information on eligibility requirements, when and how participants earn or accrue benefits and other factors relating to benefits.

What are plan operational errors?

Operational errors occur when a plan sponsor does not administer the plan in accordance with the written terms of the plan as noted in either the Plan Document or Adoption Agreement. Common examples are listed below.

Deep Dive into Common 401(k) Audit Deficiencies

Deficiencies: Having an outdated or incomplete Plan Document/Adoption Agreement or not having a written document that complies with current laws and regulations.

Resolution: Regularly review and update the plan document to ensure it reflects the most current laws and plan provisions. When changes in laws or plan design occur, it is important to formally amend the plan to ensure it remains in compliance with the current landscape. Once changes to the plan are made, ERISA requires these changes to be communicated to plan participants. Certain rules apply to the types of permitted amendments to a qualified plan such as conforming to the preapproved language in an IRS volume submitter document. The plan auditor may suggest consulting the plan’s third-party administrator (TPA) or an ERISA attorney or other professional when amending the plan based on these complexities.

Contribution Timeliness Errors

The employer is responsible for contributing the participants’ deferrals to the plan trust. The Department of Labor (DOL) requires that the employer deposits the deferrals to the trust as soon as administratively possible, but in no event can the deposit be later than the 15th business day of the following month. There is no safe-harbor for employee contributions to a large plan (i.e. a plan that requires an audit).

Deficiencies: Failure to remit contributions on a timely basis can result in the loss of your employee benefit plan’s tax favored status and may be considered a prohibited transaction.

Resolution: There are corrective programs plan sponsors may use to correct the plan once errors are found. See our blog Plan Sponsors, Did you Find an Error in Your Employee Benefit Plan? Here’s How to Correct It for insights on these programs. 

To avoid these errors in the future, the employer should develop clear and organized procedures for submitting contributions and reviewing deposits for accuracy in a timely manner. It is wise to coordinate with the payroll provider to determine when the earliest the employer can make deferral deposits. Ensure the current procedures in place are in alignment with the deposit dates coordinated with the payroll provider.

Inappropriate Use of the Plan Definition of Compensation

The Plan Document/Adoption Agreement generally will describe, at length, what is and what is not considered compensation. A common error is allocating plan contributions to participant accounts using the wrong plan definition of compensation. Typically, the mistake is a result of the employer excluding certain types of compensation (i.e. bonuses, commissions, overtime) that the definition of compensation in the plan document specifically includes. Another error is incorrectly including ineligible compensation.

Deficiencies: Failing to apply the correct definition of compensation when allocating plan contributions to participants. This can result in missed or excess deferrals, incorrect employer contributions, and compliance testing errors.

Resolution: After correcting the error, it’s essential to inform the impacted participants and share the corrective action plan. These types of mistakes can be costly for plan sponsors to fix if not found timely. It is important to confirm that payroll contributions are being processed using the correct compensation definition and providing the plan administrator with the compensation they need to complete the year-end nondiscrimination testing.

Failure to Enroll Eligible Employees

The Plan Document/Adoption agreement should have clear eligibility terms for employees. A common error is not enrolling these eligible employees into the Plan in a timely manner. While this may seem like a minor oversight, failure to enroll eligible employees can lead to significant penalties and corrective contributions. 

Deficiencies: Failure to accurately track employee eligibility and enrollment into the 401(k) Plan. Common causes for these errors include inaccurate employee data into the payroll system, communication errors between employer and TPA, misinterpretation of eligibility such as service hour thresholds and age requirements.

Resolution: Ensure the Plan Document/Adoption agreement has clear eligibility terms set forth. Regularly review and update these documents on an annual basis, if necessary. Work with your payroll provider to automate enrollment for employees that meet eligibility criteria. Conduct routine enrollment checks to verify all eligible employees have been offered enrollment. Proactively inform new hires of plan eligibility and timelines surrounding entering the Plan. As always, communication is key. 

401(k) plan audits can be daunting and complex, but they are not just a regulatory requirement, they are a critical safeguard for plan sponsors and participants. They help ensure the plan is operating in compliance with DOL and IRS rules and may also assist in identifying potential issues that can become costly. Audits help ensure participant assets are being managed properly and plan participants receive the full amount of benefits they have earned. It is important to understand common pitfalls found during these audits to ensure compliance and protect retirement benefits of plan participants.