The Frugal Fiduciary Small Business 401(k) Blog
Get the latest industry news, deadlines and tips you need to know to help tackle your fiduciary responsibility needs.
To meet IRS qualification requirements, 401(k) plans must pass nondiscrimination testing annually to ensure plan contributions do not disproportionately benefit Highly-Compensated Employees (HCEs) or exceed legal limits. While most employers hire a professional third-party administrator (TPA) to complete this work, all employers should understand the deadlines that apply to the process – which generally relate to failed testing and contribution funding. This basic knowledge can help avoid the often painful consequences of late testing – including missed tax deductions, IRS penalties, and plan disqualification.
It’s impossible to complete annual 401(k) plan testing accurately without a clear understanding of the plan sponsor’s ownership structure. This information is used to determine the company’s controlled or affiliated service group status as well as the Highly Compensated Employee (HCE) and key employee status of plan participants. To make these determinations properly, certain “family attribution” rules must be applied correctly. These IRS rules exist to thwart ownership structures that would otherwise permit a 401(k) plan to discriminate in favor of business owners.
Safe harbor 401(k) plans are the most popular type of 401(k) used by small businesses today. Unlike a traditional 401(k) plan, they automatically pass the ADP/ACP and top heavy nondiscrimination tests when mandatory contribution and participant disclosure requirements are met. This trade-off is worth it for many business owners, who often bear the brunt of the consequences when their 401(k) plan fails testing. However, a safe harbor 401(k) plan is not the best fit for every small business. They can cost more than a traditional 401(k) plan, but offer less plan design flexibility – making it harder for some business owners to meet their plan priorities
All 401(k) plan contributions have deposit deadlines – and it’s up to 401(k) fiduciaries to meet them. Yet, many employers are unclear about the deadlines applicable to their 401(k) plan. That confusion can easily lead to late contributions. When that happens, there are always consequences for the employer. They range from mild (losing a tax deduction, making participants whole for lost earnings) to severe (plan disqualification, IRS and/or civil penalties). Fortunately, these consequences are easily avoided with some basic education.
One of most effective ways an employer can persuade their employees to participate in a 401(k) plan is by matching a portion of their pre-tax or Roth 401(k) salary deferrals. This is unsurprising when you consider matching contributions are like a guaranteed return on salary deferrals - or “free” money.
Today, most 401k plans operate on a calendar-based plan year cycle. March 15 was an important date for many of these plans – it was the deadline to make any corrective distributions due to a failed 2015 plan year Average Deferral Percentage (ADP) or Average Contribution Percentage (ACP) test in order to avoid a 10% IRS excise tax. Failing an ADP/ACP test is not fun. Highly Compensated Employees (HCEs) don’t want their 401k contributions refunded (and out-of-pocket taxes increased), while employers don’t want angry HCEs or the stress of correcting a failed ADP/ACP test by March 15. Although approximately 30% of 401k plans subject to ADP/ACP testing fail, it’s an outcome most small businesses want to avoid. Below are steps a 401k fiduciary can take to do that.