Annual Administration Basics

Each year, a myriad of tasks must be completed to keep a 401(k) plan in compliance with ERISA. When considered together, these tasks can easily seem overwhelming to the typical 401(k) fiduciary. However, when they are unpacked, it’s clear they are manageable - especially when you consider that many of the more difficult and time consuming tasks will be handled by a professional Third-Party Administrator (TPA).

If you’re a 401(k) fiduciary, you need to understand your plan’s annual ERISA compliance obligations – even when you hire a TPA to take care of them for you. Why? When you delegate fiduciary responsibilities to a plan service provider, you retain an obligation to monitor that service provider for duty performance.

401(k) Administration Checklist

ERISA compliance tasks generally fall into one of four categories - testing, Form 5500 reporting, participant disclosure, and plan document maintenance.

Annual 401(k) Testing

Each plan year, ERISA requires every 401(k) plan to complete certain tests to confirm they do not discriminate in favor of Highly Compensated Employees (HCEs) or exceed IRS contribution limits. Generally, this annual testing is completed as soon as possible following the close of a plan year.

While most employers hire a professional TPA to complete this work, every employer should understand testing basics to confirm all necessary tests are completed and any failed tests are corrected each year. Otherwise, costly penalties, plan disqualification or fiduciary liability can happen.

Who is a HCE?

For 2018, A HCE is defined as an individual who meets one of the following two criteria:

  • They own more than 5% of the company (directly or by family attribution) at any time during the 2017 or 2018.
  • They received compensation in excess of $120,000 during 2017. A plan can limit this group to the top 20% of employees, ranked by compensation

Nondiscrimination Testing

401(k) plans must pass certain “nondiscrimination” tests each year to show they do not impermissibly discriminate in favor of HCEs with respect to plan benefits.

These tests include:

IRC §410(b) Coverage Testing

Purpose of Test

Ensure a sufficient number of non-HCEs are covered by a 401(k) plan.


To pass coverage testing, each contribution source (employee deferral, match, profit sharing) must satisfy either the ratio percentage or the average benefit test.

The ratio percentage test is most commonly used. To pass this test, the following calculation must equal or exceed 70%:

(# of eligible non-HCEs covered by the plan / # of eligible non-HCEs employed by the company) / (# of eligible HCEs covered by plan / # of eligible HCEs employed by the company )

Correction Method

To correct a failed coverage test, the employer may adopt a corrective amendment, up to 9½ months following the plan year-end, to retroactively expand plan coverage.


The following employee groups can be disregarded when completing a coverage test:

  • Employees who have not met a source’s age and service eligibility requirements
  • Union employees
  • Non-resident aliens with no U.S income
  • Terminated employees that worked < 500 hours during the year

A controlled group or affiliated service group is considered a single employer by ERISA.

Actual Deferral Percentage (ADP) Testing

Purpose of Test

Test employee deferrals (both pre-tax and Roth deferrals, but not catch-up contributions) for nondiscrimination.


An ADP is calculated by averaging the deferral percentages of HCEs or non-HCEs.

  • To pass the ADP test, the ADP of the HCE group cannot exceed the greater of:
    • 125% of the non-HCE group ADP, or
    • the lesser of:
      • 200% of the non-HCE group ADP, or
      • the non-HCE group ADP plus 2%.
  • The non-HCE group ADP can be based on the group’s current or prior year contributions.

Correction Method

The most common correction method is distributing excess contributions to HCEs in the amount necessary to make the ADP test pass. A 10% excise tax may apply to excess contributions distributed more than 2 ½ months following the plan year-end.


Safe harbor 401(k) plans are not subject to ADP testing


Actual Contribution Percentage (ACP) Testing

Purpose of Test

Test employer matching and after-tax contributions for nondiscrimination.


Same methodology as the ADP test.

Correction Method

Same methodology as the ADP test.


Safe harbor 401(k) plans are not subject to ACP testing

When a new comparability profit sharing contribution is made to a 401(k) plan, an IRC §401(a)(4) “General Test” is required to test the contribution’s allocation for nondiscrimination.

Top Heavy Testing

In addition to nondiscrimination testing, 401(k) plans are subject to a Top Heavy Test (IRC §416). A 401(k) plan is considered top heavy for a plan year when the account balances of Key Employees exceeded 60% of total plan assets on the last day of the prior plan year.

When a 401(k) plan is top heavy, non-Key Employees must generally receive an employer contribution equal to 3% of their annual compensation. Any employer matching or profit sharing contributions can be used to offset this top heavy minimum contribution requirement. Safe harbor 401(k) plans automatically satisfy the minimum contribution requirement if safe harbor contributions are the only contributions made to the plan during the year.

A Key Employee is defined as any employee (including former or deceased employees), who at any time during the plan year was:

  • An officer making over $175,000 (2018)
  • A 5% owner of the business
  • An employee owning more than 1% of the business and making over $150,000 for the plan year

Participant limits testing

In addition to plan-level testing, participants must be tested each year to confirm the contributions made to their account do not exceed IRS limits. These limits include:

  • Annual Additions Limitation (IRC §415) – “Annual Additions” represent the sum of employee and employer contributions (including any reallocated forfeitures) made to a participant’s account during the limitation year (generally, the plan year). For 2018, the 415 limit was the lesser of:
    • 100% of the participant’s compensation
    • $55,000 ($61,000 including catch-up contributions)
  • Elective Deferrals Limitation (IRC §402(g)) – This limit applies to total pre-tax and Roth 401(k) contributions. For 2018, the 402(g) limit was $18,500 ($24,500 for catch-up eligible participants). Any 402(g) excess contributions must be distributed by April 15 of the following year to avoid double-taxation to the participant.

Annual Testing is Important

401(k) plans offer valuable tax benefits to employers and employees alike. These benefits are not free, however – to be eligible, employers must keep their 401(k) plan in compliance with IRS qualification requirements.

401(k) Document Retention

Did you know that ERISA requires all employers to retain detailed 401(k) documents, including testing results, transactions and employee activity – for at least 6 years? If you did not, you’ve got a lot of company. Nevertheless, it’s important to understand and comply with these rules. While only small civil penalties are possible, if required plan records are not preserved, missing records can make it more difficult for a 401(k) sponsor to defend plan operations or the accuracy of benefit payments if they are ever challenged by the IRS, DOL or plan participants. That can increase liability.

In general, 401(k) plan records must be kept for a period of not less than six years after the filing date of the IRS Form 5500 created from those records. However, records necessary to a participant’s claim for plan benefits must be kept longer. These records must be kept “as long as a possibility exists that they might be relevant to a determination of the benefit entitlements of a participant or beneficiary.” This can mean indefinitely.

Some of the most common plan records a 401(k) sponsor must retain are itemized below. To organize this information, I recommend using three files – a file to store documents that govern plan operation (a “Plan Document File”), a file for participant records (a “Participant File”), and a file for plan year information (a “Plan Year File”). This simple three file system should make it easy to access plan records if they are ever needed.

Plan Document File

This file should contain the plan’s operating documents. As items in this file are replaced by new documents, it is recommended you archive each replaced item in a safe spot for historical reference.

Items to keep in the Plan Document File include:

  • Plan Documents – adoption agreement, base document, IRS advisory letter, amendments, QDRO policy, and loan policy (if loans are permitted)
  • Participant Disclosures – Summary Plan Description (SPD), Summary of Material Modification (SMM)
  • Corporate Actions – resolutions, agendas, minutes, and documents distributed at meetings
  • Service Agreements – Includes all plan service provider contracts
  • 408b-2 Fee Disclosure(s) – Includes fees and services delivered by plan service providers
  • Fidelity Bond – ERISA Section 412(a) requires every fiduciary of an employee benefit plan and every person who handles funds or other plan property be bonded.

Participant File

This file should contain forms provided by plan participants. Generally, these forms direct the 401(k) sponsor to take certain actions on the participant’s behalf.

This file should contain forms provided by plan participants. Generally, these forms direct the 401(k) sponsor to take certain actions on the participant’s behalf.

  • Payroll Records
  • Participant Deferral Election Forms
  • Investment Election Change Forms
  • Beneficiary Designation Forms
  • Distribution Request Forms (with any supporting documentation)
  • Loan Request Forms
  • Rollover Requests
  • QDRO Split Requests (with supporting documentation)

Plan Year File

This file should contain important records related to a plan year. A Plan Year file should exist for each plan year the plan has existed.

Items to keep in the Plan Year File include:

  • Annual Valuation – Contains participant-level transaction information for the plan year, including contribution, distribution and fee activity. If received quarterly, file all four quarters. 
  • Annual Trustee/Custodian report – Contains trust-level transaction information for the plan year, including all purchases and sales that occurred in trust. If received quarterly, file all four quarters.
  • Annual Nondiscrimination Testing – 401(k) plans have various testing requirements. Most common tests include:
    • Coverage (IRC Section 410(b)) testing
    • Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) testing (non-safe harbor 401(k) plans only)
    • Excess Deferral (IRC Section 402(g)) testing
    • Annual Addition (IRC Section 415(c)) testing
    • Top Heavy (IRC Section 416) testing
    • Rate Group (IRC Section 401(a)(4)) testing (“new comparability” plans only)
  • Annual Participant Notices – Any notices provided to participants, including (as applicable):
    • Participant fee disclosure (ERISA 404a-5) notice
    • Safe harbor 401(k) plan notice
    • Qualified Default Investment Alternative (QDIA) notice
    • Automatic (negative) enrollment notice
  • Form 5500 – Copy of Form 5500 with related schedules as filed with Department of Labor (DOL)
  • Independent Audit Report – If required to be filed with Form 5500
  • Summary Annual Report – Summary of Form 5500 provided to participants

Don’t get into trouble when document retention is easy

A retirement plan, by its very nature, generates large amounts of documentation and preserving much of it is required by ERSIA. Developing a filing system can make it easy for 401(k) sponsors to review, update, preserve, and dispose of documents.

These systems do not need to be complex. A simple system with 3 file types can do the trick. Ready access to plan documentation can mean the difference between a quick, cost-free settlement to a 401(k) dispute or a drawn-out, costly battle.