Avoiding Costly Errors: Common 401(k) Plan Mistakes That Can Trigger IRS Penalties
A well-designed 401(k) plan is a powerful tool for attracting top talent, retaining employees, and helping them build long-term financial security. However, even well-managed plans can run into compliance issues. To the IRS, even a small mistake can lead to serious consequences, including fines, penalties, or even disqualification of the plan.
The good news? Most of these issues are avoidable with the right knowledge, oversight, and partner by your side.
At Maxus Plan Solutions, we help business owners identify and resolve compliance issues before they become costly problems. In this article, we will walk through the most common mistakes that trigger IRS penalties, and show you how to steer clear of them.
1. Late Deposit of Employee Contributions
Timing is everything, especially when it comes to depositing employee deferrals. The Department of Labor requires that employee contributions be deposited “as soon as administratively possible”, and no later than the 15th business day of the following month. But in reality, most plans are expected to remit deposits within a few days of payroll.
Why it matters: Late deposits can trigger excise taxes, lost earnings, and increased audit risk. Repeating offenses can escalate scrutiny.
How to avoid it: Automate the transfer of payroll contributions and review your deposit schedule regularly to ensure timely remittance.
2. Failed ADP/ACP or Top-Heavy Testing
Annual nondiscrimination testing is designed to ensure that plans don’t disproportionately benefit highly compensated employees (HCEs). If your plan fails ADP/ACP testing or Top-Heavy status, you may be required to issue corrective distributions or make additional employer contributions.
Why it matters: Failure can require issuing refunds to certain employees or making corrective contributions. Delays in addressing failures may result in additional penalties.
How to avoid it: Consider adopting a Safe Harbor plan implementing automatic enrollment and escalation features to help improve testing outcomes.
3. Plan Document Errors or Operational Misalignment
Your 401(k) plan must operate according to its governing document. If your actual practices deviate, such as allowing employees to participate before they’re eligible or using the wrong definition of compensation, you are out of compliance.
Why it matters: Misalignment between plan documents and operations is a red flag for auditors and can lead to plan disqualification if uncorrected.
How to avoid it: Conduct regular plan reviews to ensure that operational practices align with what is outlined in your written plan document. Update documents promptly when plan changes occur.
4. Incorrect Compensation Calculations
Calculating contributions using the wrong definition of compensation (for example, excluding bonuses or commissions when they shouldn’t be) is one of the most common and costly mistakes.
Why it matters: Inaccurate contributions often require expensive corrections and may impact employees’ retirement savings.
How to avoid it: Ensure your payroll system matches the compensation definition in your plan. Train your payroll team to apply the correct calculations consistently.
5. Missing Required Participant Notices
Many plans are required to provide participants with annual notices, like Safe Harbor, QDIA, or automatic enrollment disclosures. Failing to distribute these on time can cause compliance violations and limit your plan’s design flexibility.
Why it matters: Without proper notice, your plan may lose Safe Harbor protection or other valuable features.
How to avoid it: Use a system or provider that tracks notice deadlines and automates the distribution process to participants.
6. Inadequate Fiduciary Oversight
Every 401(k) plan has fiduciaries, often business owners, HR managers, or finance leaders who are responsible for overseeing the plan in the best interest of participants. But many fiduciaries don’t realize the extent of their responsibilities.
Why it matters: Failure to monitor plan fees, review investments, or document decisions can expose fiduciaries to personal liability, lawsuits, and regulatory penalties.
How to avoid it: Establish a formal oversight process and work with a trusted third-party administrator who can help support your compliance and administrative needs.
How Maxus Plan Solutions Can Help
At Maxus Plan Solutions, we support business owners with tailored 401(k) compliance and administration services, including:
- Plan document and operational reviews
- Compliance testing and correction support
- Payroll and contribution monitoring
- Compliance and administrative support for plan sponsors
- Participant notice tracking and distribution
We don’t just administer your plan: we protect it.
Final Thoughts: Prevention Is Better Than Penalties
The most damaging 401(k) mistakes are often small, unnoticed errors that build up over time. With proactive compliance support, these risks can be minimized or eliminated altogether.
If you’re unsure about the health of your retirement plan, let’s take a closer look together. Contact Maxus Plan Solutions for a plan compliance review and expert guidance on keeping your 401(k) penalty-free.
Build smarter. Stay compliant. Protect your plan.