Retirement plan compliance testing is a critical aspect of managing a 401(k) or similar employer-sponsored retirement plan. It ensures that the plan operates within the regulatory frameworks set by the IRS and the Department of Labor. Unfortunately, failing these compliance tests can have significant consequences for both employers and employees.
Here’s what you need to know:
#1 Corrective Distributions
Failing the Actual Deferral Percentage (ADP) or Actual Contribution Percentage (ACP) tests can lead to corrective distributions. This means highly compensated employees (HCEs) might receive a refund of their contributions to the plan, which is then taxed as income. This not only affects the employee's retirement savings but can also lead to dissatisfaction among your key talent.
#2 Tax Penalties
Both employers and employees can face tax penalties for non-compliance. Employers might be subject to excise taxes for failing to make the necessary corrections within the prescribed timeframe. Additionally, corrective distributions to HCEs can increase their tax liability, affecting their net income and satisfaction with the retirement plan offerings.
#3 Plan Disqualification Risk
While rare, severe non-compliance issues can lead to plan disqualification. This would make all plan assets taxable and remove the tax benefits associated with the retirement plan, significantly impacting all plan participants and the sponsoring employer.
#4 Increased Scrutiny and Costs
Failing compliance tests can lead to increased scrutiny from regulatory bodies, potentially resulting in more frequent audits and the associated costs. It can also increase the administrative burden on the plan sponsor, requiring more time and resources to manage the plan effectively.
#5 Employee Morale and Retention
The implications of failing retirement plan testing extend beyond financial penalties. They can affect the perception of the company among employees, potentially impacting morale and retention. A retirement plan is a valuable benefit, and its mismanagement can lead to dissatisfaction and turnover.
Action Steps:
To avoid these consequences, employers should proactively engage with their plan administrators to ensure ongoing compliance, consider plan design changes that reduce the risk of failing tests, and educate their employees about the importance of balanced contributions across all compensation levels.
Engaging a knowledgeable retirement plan consultant can also help navigate the complexities of compliance, ensuring your plan remains an asset rather than a liability.
Let’s discuss more on how we can ensure our retirement plans are robust, compliant, and beneficial for all.
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