One of the most common problems we see when planning 401(k) audits is the plan sponsor’s failure to follow the terms of the plan document. This happens for a myriad of reasons, ranging from not understanding the document to not having enough experience with 401(k) plans to understand that there even is a document that governs the operations and defines important terms. There are two issues that arise because of this overall problem: reporting incorrect eligible compensation for compliance testing and incorrect calculation of eligibility and entry dates.
The definition of eligible compensation can be downright cumbersome at best, but that doesn’t alleviate your responsibility to understand it and apply it correctly. In your adoption agreement, someone chose what types of pay would be used to determine deferrals. Look for something that discusses gross wages, bonuses, overtime, commissions, etc.
As plan administrator, you need to apply that formula on a test basis to ensure that your payroll system is calculating employee deferrals using the correct pay. If not, the plan is out of compliance, and the company could owe a lot of money when the 401(k) audit is filed because you will need to correct the issue for as far back as it goes. Here is where you hope that someone checked this when the plan began!
If you have trouble finding the definition or determining if it is calculating correctly, ask for help. Your TPA should be able to help you, or PriceKubecka would be happy to do a calculation on a sample of your employees.
Many plans require the employee to meet some requirements before allowing them to participate: commonly, they must be at least 21 years old and have completed a defined number of months before becoming eligible. After determining eligibility, there are even further rules defining when they can contribute to the plan, which is their entry date. Rules can range from immediate entry to having to wait for the next month, quarter, or year.
Like eligible compensation miscalculations, if employee eligibility or entry dates are miscalculated, the plan is out of compliance and missed contributions may be owed – another red flag that will show up in a 401(k) audit. Even more complexity can come into play with automatic enrollment features, but we’ll cover that in a later post.
Get familiar with your adoption agreement – it defines exactly how the plan should run, so follow it! Keep reading to learn about Pitfall #3: Incorrectly Remitting Employees Contributions to Their 401(k) Plans.