Last year, PriceKubecka performed nearly 500 401(k) audits. We saw a lot of issues. But after late deposits, one stood out: Eligible compensation errors
They’re common. They’re confusing. And if ignored, they can get expensive. The good news? They’re fixable—and preventable.
What Is “Eligible Compensation” in a 401(k) Plan?
Most employers hear “compensation” and only think salary/wages. But your plan document may include (or exclude) much more including overtime, bonuses, commissions, and tips.
And that’s where problems start.
Key question:
If an employee elects to defer 4%, do you know exactly what that 4% applies to?
If your payroll team doesn’t know—or your system isn’t set up correctly—you likely have errors.
The Most Common Issue: Getting Compensation Wrong
When plans don’t follow their own definition of eligible compensation, it leads to:
- Understatements (missed deferrals or employer contributions)
- Overstatements (too much contributed)
Why does this happen?
- Misconfigured payroll codes
- Payroll provider changes
- Lack of internal training
- Plan rules not aligned with payroll setup
At its core, this is a system + awareness problem.
How to Fix Missed Compensation (Exclusions)
If eligible compensation was excluded, it creates a: Missed Deferral Opportunity (MDO)
That means employees missed the chance to contribute to their retirement.
Correction typically requires:
- QNEC (Qualified Non-Elective Contribution)
- 25%–50% of the missed deferral
- 100% of missed employer match
- Lost earnings
💡 Timing matters:
- Fix it quickly → ~25% correction
- Delay → up to 50%
Can you self-correct?
Often, yes. If the error is operational and fixed within two years, it may qualify for IRS self-correction (SCP). For long-term or complex issues, involve an ERISA attorney.
How to Fix Overstated Compensation (Inclusions)
If too much compensation was included, corrections are usually simpler:
- Retroactively amend the plan, OR
- Return excess contributions to participants
Which route is best? It depends on your facts and circumstances. Always coordinate with your TPA, auditor, and ERISA counsel.
How to Prevent Eligible Compensation Errors (Best Practices)
This is where most plans win—or keep repeating mistakes.
- Simplify Your Plan Definition
Use a clear, consistent definition of compensation across all contribution types.
- Align Payroll + Plan Rules
Every payroll change should trigger one question: Does this impact eligible compensation?
- Control Pay Codes
Before adding new pay codes:
- Define how they’re treated in the plan
- Map them correctly in payroll
- Perform quarterly or semi-annual payroll audits:
- Review all wage codes
- Check for anomalies
- Validate calculations
- Train Your Team (Every Year)
Your payroll and HR teams should clearly understand:
- What counts as compensation
- How deferrals are calculated
- Where errors typically occur
Why This Matters for Your 401(k) Audit
Eligible compensation errors are one of the most common audit findings—and one of the most preventable. Left unchecked, they can lead to:
- Costly corrections
- Compliance risk
- Frustrating, time-consuming audits
Handled correctly, they become a non-issue.
Work With a 401(k) Audit Specialist
At PriceKubecka, we don’t just identify errors—we help you avoid them. Our approach:
- Full-population testing (not sampling)
- Smarter upfront data requests
- Minimal back-and-forth
- Typically <5 hours of your time
👉 Flat-fee 401(k) audits. No surprises. No chaos.
Need Help Fixing or Preventing Compensation Errors?
If this showed up in your audit—or you want to make sure it doesn’t next year—we can help.
Frequently Asked Questions
What is a missed deferral opportunity (MDO)?
A missed deferral opportunity (MDO) occurs when an employee’s eligible compensation was not properly included, causing them to miss contributions to their 401(k). This is considered an operational error and typically requires corrective contributions from the employer.
What causes eligible compensation errors in 401(k) plans?
The most common causes include:
- Incorrect payroll system setup
- Misclassified or new pay codes
- Changes in payroll providers
- Lack of training or oversight
- Plan definitions not aligned with payroll
How can employers prevent 401(k) compensation errors?
To prevent errors:
- Use a simple, consistent compensation definition
- Align payroll systems with plan rules
- Review pay codes regularly
- Conduct periodic payroll audits
- Train HR and payroll teams annually
Are eligible compensation errors common in 401(k) audits?
Yes. Eligible compensation errors are one of the most frequently identified issues in 401(k) audits, second only to late deposits. They are also one of the most preventable with proper processes in place.
What happens if eligible compensation errors are not corrected?
Uncorrected errors can lead to:
- IRS and DOL compliance issues
- Financial penalties
- Required plan corrections
- Increased audit scrutiny
