5 Mistakes Plan Sponsors Make During Annual Compliance Testing—and How to Avoid Them
As a 401(k) plan sponsor, annual compliance testing helps ensure that your plan meets IRS and Department of Labor (DOL) requirements.
Compliance testing helps verify that your plan benefits both highly compensated employees (HCEs) and non-HCEs in a balanced manner.
However, many plan sponsors unknowingly make mistakes during the process, resulting in costly corrections, fines, or even plan disqualification.
Below are the five most common mistakes and how to avoid them.
1. Inaccurate Data Submission
Compliance testing is based on data from payroll, employee compensation, and plan contributions. If this data is inaccurate or incomplete, the results of the testing can be compromised, leading to failed tests.
How to Avoid:
- Regular Data Audits: Schedule quarterly audits to ensure that all compensation data, participant deferrals, and plan contributions are correctly recorded.
- Coordinate with Payroll and TPA: Work closely with your payroll provider and third-party administrator (TPA) to ensure that data is accurate and updated in real time. Regular communication between these parties ensures consistency across all data points.
- Automate Where Possible: Use technology solutions that integrate payroll and retirement plan data to reduce manual entry and minimize errors.
2. Neglecting Highly Compensated Employees (HCEs)
Highly compensated employees (those who earn over a certain threshold, typically $135,000 or more) are subject to stricter compliance requirements under nondiscrimination tests. If HCEs contribute too much compared to non-HCEs, your plan could fail nondiscrimination testing.
How to Avoid:
- Monitor Contributions for HCEs: Regularly monitor the contribution levels for HCEs to ensure they remain within the limits allowed by the plan.
- Safe Harbor Plans: Consider adopting a safe harbor 401(k) plan, which automatically satisfies many nondiscrimination tests. This can simplify testing and reduce the risk of failure.
- Adjust Contributions Mid-Year: If HCE contributions are outpacing those of non-HCEs, take corrective action before the end of the year. This may involve reducing HCE deferrals or implementing a catch-up strategy.
3. Failure to Monitor Plan Design
An outdated plan design can cause compliance issues. For example, if your plan was designed for a smaller workforce but has since expanded, the plan may no longer comply with regulations or meet your employees' needs.
How to Avoid:
- Regular Plan Reviews: Conduct a comprehensive review of your plan design at least every two years. Involve both HR and your retirement plan advisor in the review to ensure it reflects the company’s size, workforce, and goals.
- Adapt to Changing Demographics: As your company grows or shifts demographics, make adjustments to your plan design, such as modifying eligibility requirements or changing matching contributions.
- Employee Feedback: Survey employees periodically to gather feedback on how well the plan serves their retirement needs. Use this data to tweak your plan's design for better employee engagement and compliance.
4. Procrastinating on Mid-Year Testing
Waiting until year-end to evaluate compliance can leave little time to address any issues that arise. If issues are discovered too late, there may not be enough time to take corrective action, such as refunding excess contributions or making necessary plan amendments.
How to Avoid:
- Mid-Year Checkpoints: Perform a "pre-testing" evaluation at mid-year to assess your plan’s progress. By identifying problems early, you’ll have more time to make corrections.
- Work with a TPA: Many TPAs offer mid-year compliance reviews to spot potential issues before year-end.
- Document Early Actions: If you identify issues early, document your correction actions thoroughly to ensure a smooth year-end process.
5. Ignoring Participant Communication
Participant engagement is critical to passing compliance tests. A lack of communication and education can lead to low deferral rates, especially among non-HCEs, and result in nondiscrimination issues.
How to Avoid:
- Invest in Participant Education: Provide ongoing education through webinars, one-on-one consultations, and educational materials to help employees understand the benefits of saving for retirement.
- Encourage Automatic Enrollment: Automatic enrollment ensures that employees begin saving for retirement as soon as they become eligible, boosting participation and contributing to better test results.
- Offer Financial Wellness Programs: Implement programs that help employees manage their overall finances. This can improve deferral rates and, by extension, compliance results.
By taking proactive steps to avoid these common mistakes, you can help ensure that your 401(k) plan remains compliant and optimized for both your business and your employees.
Need help or looking to make changes for the plan year ahead? We can help! Simply email info@equity401k.com or call the office at 626-224-7715.