401(k) plan compliance guide

Why 401(k) compliance is a growing priority for businesses

401(k) compliance is no longer a routine administrative task – it’s a critical part of retirement plan oversight that directly impacts an organization's financial integrity. With regulatory scrutiny a possibility from the Internal Revenue Service (IRS) and Department of Labor (DOL), plan sponsors are under pressure to meet stringent retirement plan compliance requirements and pass annual 401(k) compliance testing. Doing so is necessary to help avoid costly penalties, employee refunds or even plan disqualification.

A financial advisor’s role in supporting 401(k) plan compliance is more valuable than ever. Common 401(k) problems – like failed nondiscrimination tests, contribution errors and untimely filings – can quickly escalate into significant 401(k) compliance issues. By helping clients identify red flags early, navigate annual retirement plan compliance testing and take corrective action when needed, a financial advisor becomes an indispensable partner in helping reduce fiduciary risk and keeping retirement plans audit-ready.

What is 401(k) compliance testing?

401(k) compliance testing is critical to annual retirement plan compliance and a valuable opportunity for financial advisors to deliver proactive oversight. The IRS-mandated tests are designed to ensure 401(k) plans do not unfairly favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).

Key 401(k) compliance tests include:

• Actual deferral percentage (ADP) test
  Verifies that HCEs are not deferring a significantly higher percentage of their compensation than NHCEs. Plans fail the ADP test if the disparity is too great, in which case employers need to refund contributions from HCEs to lower their average deferral percentage. The refunds are taxable as ordinary income in the year received, potentially leading to tax bills for HCEs.
• Actual contribution percentage (ACP) test
  Measures employer matching and after-tax contributions for equitable treatment across employee groups.
• Top-heavy test
  Assesses whether key employees hold more than 60% of plan assets. If so, the plan is considered top-heavy and requires minimum employer contributions for NHCEs.
• 410(b) coverage test
  Verifies the 401(k) plan meets minimum coverage requirements by including a broad, nondiscriminatory employee base.
• 415(c) limit testing
  Confirms that annual retirement plan contributions stay within IRS limits (currently $70,000 or 100% of compensation, whichever is less).

It’s essential for financial advisors who support plan sponsors to understand 401(k) compliance testing and how to navigate it. Failed 401(k) compliance tests can trigger corrective actions, such as refunds, plan adjustments or qualified non-elective contributions (QNECs). Advisors who monitor test results, spot potential 401(k) compliance issues early and implement corrective strategies help their clients avoid costly errors.

Five most common 401(k) compliance issues

1. Plan eligibility

A frequent 401(k) compliance issue is failing to track and enforce eligibility requirements. Mistakes, such as recording incorrect hiring dates or allowing ineligible employees to defer contributions, can result in operational errors.

2. Contribution limits

Employees sometimes exceed IRS limits on elective deferrals or annual additions. Advisors can monitor deferral rates and work with plan sponsors to manage excess contributions through timely corrections and recharacterizations.

3. Timely remittance of employee contributions

The DOL mandates that employee deferrals be deposited generally “as soon as reasonably possible.” Late deposits are a red flag for auditors and can result in excise taxes and corrective actions.

4. Late filings

Failure to file Form 5500 on time or to meet other annual reporting obligations can lead to stiff penalties and extended audits.

5. Participant loans

Improper loan documentation or defaults can create unintended taxable events. Advisors can help by ensuring loan policies are compliant and outstanding loans are monitored.

What are the rules and requirements of offering a 401(k) plan?

Plan sponsors must comply with both IRS and Employee Retirement Income Security Act (ERISA) requirements to maintain the tax-qualified and ERISA-compliant status of their plan. Their responsibilities include:

• Maintaining and updating a written plan document
• Tracking employee eligibility and enrollment accurately
• Filing Form 5500 annually
• Delivering required notices and disclosures
• Ensuring timely contribution deposits and accurate record keeping

Noncompliance in any of these areas can lead to 401(k) compliance issues, which if not corrected, could lead to disqualification of the plan.

How to help clients maintain 401(k) compliance

Financial advisors can proactively mitigate 401(k) problems

Help clients maintain 401(k) compliance year-round by:

• Conducting annual plan reviews
• Suggesting a safe harbor design to eliminate 401(k) compliance testing failures
• Educating clients about deadlines and documentation
• Partnering with third-party administrators (TPAs) for early issue detection and correction

What if a plan fails 401(k) compliance testing?

When a client’s plan fails 401(k) compliance testing, like the ADP or ACP test, it’s critical to quickly correct the issue and preserve the plan’s tax-qualified status. The financial advisor’s role is to guide the sponsor through IRS-approved correction methods, which include:

• Refunding excess contributions
  Plans that fail nondiscrimination tests may need to return excess contributions (and any attributable earnings) to HCEs within 2.5 months of the plan year-end to avoid additional excise tax. Advisors can help monitor prompt testing and, if required, distribution of excess contributions.
• Making qualified non-elective contributions (QNECs)
  An alternative to issuing refunds is making fully vested QNECs to NHCEs to balance the plan’s deferral ratios. This option helps maintain plan participation levels and allows HCEs to retain more of their contributions.
• Using the employee plans compliance resolution system (EPCRS)
  If compliance errors occur and/or aren’t corrected quickly, advisors can help their clients resolve the issue under available IRS EPCRS programs, including self-correction. If the error is eligible for self-correction, sponsors can correct it without IRS notification or fees.

By providing expert oversight and early intervention, financial advisors can help clients restore retirement plan compliance, avoid unnecessary taxes or penalties, and reduce fiduciary exposure. An advisor’s knowledge of correction methods and partnerships with TPAs and recordkeepers are indispensable to plan sponsors.

Key stats on why 401(k) compliance matters

Use these facts and data points to help clients understand the stakes and show the value of compliance support.

1. Penalties can add up fast
   Filing Form 5500 late can result in time-consuming correction and potentially costly IRS and DOL penalties. Advisors can work with their clients to correct late filings as soon as possible and help mitigate penalties and fiduciary exposure.
2. Common IRS compliance failures
   Top issues include eligibility errors, excess contributions and missed required minimum distributions (RMDs).
3. Safe harbor plans minimize risk
   Safe harbor 401(k)s automatically satisfy key compliance tests, reducing correction costs and stress.

How ADP can help financial advisors

ADP helps financial advisors save time, minimize administrative tasks and better serve their retirement plan clients with resources like:

• Real-time testing tools and alerts
• Streamlined Form 5500 prep and filing
• Access to third-party fiduciaries and 3(16) service providers
• Holistic support and resources via the Advisor Access portal

Conclusion: Turning 401(k) compliance into a competitive advantage

Proactive 401(k) plan compliance builds trust and reinforces an advisor’s strategic value. Helping clients stay compliant enhances client retention, minimizes penalties and prevents 401(k) problems before they escalate.

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ADP Inc. owns and operates the ADP.com website. Unless otherwise disclosed or agreed to in writing with a client, ADP, Inc. and its affiliates (ADP) do not endorse or recommend specific investment companies or products. Please consult with your own advisors for such advice. Investment options are available through the applicable entity(ies) for each retirement product. Investment options in the “ADP Direct Products” are available through either ADP Broker-Dealer, Inc. (ADP BD), Member FINRA, an affiliate of ADP, Inc., One ADP Blvd, Roseland, NJ 07068 or (in the case of certain investments) ADP, Inc. Only registered representatives of ADP BD may offer and sell ADP retirement products and services or speak to retirement plan features and/or investment options available in any ADP retirement products.