401(k) Plan Reviews Help Avoid Compliance Mistakes
Although 401(k) plans offer employers and employees important tax-favored tools for retirement savings, they are considered tax-qualified retirement plans under the Internal Revenue Code (“IRC”) and are regulated by the Employee Retirement Income Security Act (“ERISA”). This means they are subject to numerous legal compliance requirements at both the setup stage and throughout the life of the plan.
To ensure continued compliance, employers should routinely assess their 401(k) plans against applicable rules and regulations—ideally at least once each year. Failing to comply can result in disqualification under the IRC, loss of tax benefits, and potential financial and legal penalties.
Below is a regular-use checklist to help ensure your 401(k) plan stays in operational compliance:
Timely Plan Amendments. As with any tax-qualified plan, 401(k) plans must be updated promptly to reflect any legally required changes—whether introduced by law, regulation, or other government mandates. Discretionary changes, such as modifying contribution levels, must also be incorporated. Plan document updates often require corresponding changes to the Summary Plan Description (SPD) or, when necessary, a Summary of Material Modifications (SMM).
Operate According to the Plan’s Terms. Administering the plan in a way that deviates from its documented provisions can trigger tax issues and breaches of fiduciary duty under ERISA.
Apply the Correct Definition of “Compensation.” It’s essential to use the proper compensation definition specified in the plan when calculating contributions and to meet the IRC’s nondiscrimination testing standards.
Types Of 401(k) Plans
There are two main types of 401(k) plans:
Traditional 401(k): Contributions are made pre-tax, lowering taxable income now, but withdrawals in retirement are taxed.
Roth 401(k): Contributions are made with after-tax dollars, so qualified withdrawals in retirement are tax-free.
The 401(k) plan offers several benefits including tax advantages, employer matching contributions, high contribution limits, and protections from creditors in some cases more about this.
Employer Match: Employers often match a portion of your 401(k) contributions, boosting your savings. Matches don’t count toward your personal limit but do count toward the total plan limit. Always try to get the full match.
Contribution Limits (2025): Under 50 can contribute $23,500; 50+ can add $7,500 catch-up; ages 60-63 may contribute up to $34,750. Total contributions with employer match can reach $70,000+.
Creditor Protection: 401(k) funds are protected from creditors under ERISA, even in bankruptcy, but withdrawn funds lose this protection.
Retirement Plan Sponsors: Your Essential Responsibilities Explained
Comply With Applicable Contribution Nondiscrimination Tests.
401(k) plans are subject to special nondiscrimination tests applicable to elective salary deferrals (pre-tax and Roth contributions) on the one hand and to matching contributions and employee after-tax contributions on the other. These tests generally limit the contribution amounts allocated to higher-paid participants. Failure to promptly correct noncompliance with these nondiscrimination tests can result in additional tax penalties for the employer.
Ensure all Eligible Employees Have the Opportunity to Participate in the Plan.
Improperly excluding eligible employees from the 401(k) plan may result in “corrective additional contributions” made by the employer to the plan.
Ensure Elective Salary Deferral Contributions do not Exceed the Annual Limit.
Elective salary deferral contributions under all 401(k) plans are subject to an IRS-prescribed annual calendar year limit. For 2019, the dollar limit for elective salary deferrals to all 401(k) plans is $19,000. For participants aged 50 or older during 2019, the dollar limit for “catch-up” elective salary deferrals is an additional $6,000 (if the plan otherwise permits such catch-up contributions). These dollar limits are subject to annual adjustments by the IRS based on changes in the “cost of living.”
Ensure Plan Loans are Property Administered.
While participants may borrow from their account under a 401(k) plan (if the plan permits loans), if such loans do not comply with legal requirements or are not timely repaid, the amount of such loan will be taxable to the participant.
Ensure “Hardship” Distributions are Properly Administered.
401(k) plans may allow participants to receive a distribution while employed if they have an “immediate and heavy” financial need that generally cannot be met from other available financial sources. Hardship distributions must be made in accordance with legally compliant plan terms and procedures. The regulatory rules for hardship distributions were recently revised and liberalized by the IRS.
Is a “Top-Heavy” Plan Minimum Contribution Required?
Suppose a 401(k) plan is a “top-heavy” plan (i.e., account balances for “key employees” exceed 60% of account balances for all participants). In that case, the plan will be subject to a minimum contribution requirement for all “non-key employees.” Top-heavy plan status is generally more common among small employer plans.
Timely Form 5500 Annual Reporting Requirement.
401(k) plans must file annual information returns (Form 5500 Reports) with the U.S. Department of Labor. The type of Form 5500 report and the scope of the report information required depends generally on the plan size (e.g., plans with 100 or more participants typically must include an independent plan auditor report with the Form 5500 filing). Failure to file Form 5500 reports promptly (generally by the end of the seventh month following the plan year’s end unless such filing due date is extended) can result in significant late filing penalties.
