401(k) Plan Reviews Help Avoid Compliance Mistakes
Although 401(k) plans offer employers and employees a powerful, tax-advantaged method to save for retirement, they are categorized as tax-qualified retirement plans under the Internal Revenue Code (IRC) and governed by the Employee Retirement Income Security Act (ERISA). As a result, they are subject to a wide range of compliance obligations under both sets of rules, from plan inception through ongoing administration.
To maintain compliance, employers must regularly evaluate their 401(k) plans to ensure they meet all regulatory requirements. This evaluation should be conducted at least annually. Neglecting these responsibilities may result in the plan’s disqualification under the IRC, loss of tax benefits, and exposure to fines or legal consequences.
Here is a periodic checklist to help monitor 401(k) plan operational compliance:
Timely Plan Amendments. As with all tax-qualified plans, 401(k) plans must be promptly amended to reflect legally mandated changes—from new laws, regulations, or federal guidance—and may also include optional updates, such as revised contribution limits. Updates to the plan document typically require corresponding changes to the Summary Plan Description (SPD) or a Summary of Material Modifications (SMM), when applicable.
Operate According to the Plan’s Terms. Administering a plan in a way that differs from its official terms can result in IRS penalties and is considered a fiduciary breach under ERISA.
Use the Proper Definition of “Compensation.” The plan must consistently use the correct definition of “compensation,” as this impacts how contributions are calculated and plays a critical role in satisfying nondiscrimination testing rules under the IRC.
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.
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