Avoid common operation and design issues

An effective compliance program includes a proactive annual review of retirement plan operation and design. Add value to your service and help your clients avoid nine common issues that may result in negative tax consequences for both plan sponsors and participants.


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Identifying employer as CG or ASG

Problem: Failure to properly identify an employer as a controlled group (CG) or an affiliated service group (ASG)
Types of plans affected: 401(a), 401(k) and 403(b)

Failure to properly identify one or more employers may result in unreliable 410(b) coverage test results, inaccurate compensation reporting, improper distributions and ineligible contributions.


It’s essential to correctly identify the plan sponsor. A tax professional may be able to determine whether it’s a controlled group (CG) or an affiliated service group (ASG). If there are other company names on the letterhead, multiple locations, different locations of decision-makers or foreign ownership, the employer may be part of a CG or an ASG.

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Including ineligible employees

Problem: Ineligible employees included as participants
Types of plans affected: 401(a), 401(k) and 403(b)
Including ineligible employees jeopardizes a plan’s qualified status. Review eligibility requirements in the plan document to ensure that only eligible employees are included as participants. Both employees and independent contractors must be classified correctly.

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Incorrect compensation

Problem: Using incorrect compensation for plan purposes
Types of plans affected: 401(a), 401(k) and 403(b)


Providing incorrect compensation may lead to both unreliable test results and inappropriate allocation of contributions.


Incorrect compensation violates the terms of the plan document, and testing based on incorrect compensation may not properly identify nondiscrimination failures.


Compensation must be reported to the recordkeeper as defined in the plan document. Periodically review reported compensation to ensure compliance.

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Annual additions limit

Problem: Failure to pass the annual additions limit (IRS Section 415)
Types of plans affected: 401(a), 401(k) and 403(b)


Annual additions in excess of Section 415 limits that aren’t corrected may jeopardize a plan’s qualified status. Review plan design and take any necessary steps to amend it to prevent Section 415 failures. The plan design should encourage contributions within the prescribed limits.

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Actual Deferral and Actual Contribution Percentage tests

Problem: Failure to pass the Actual Deferral Percentage test (ADP) and the Actual Contribution Percentage test (ACP)
Types of plans affected: 401(k) and 403(b)


If these failures aren’t corrected in a timely manner, the plan may lose its qualified status and the plan sponsor may owe an excise tax.


Consider adopting a safe harbor plan design, which allows the plan to automatically pass the ADP and ACP tests, provided all the requirements are met.


The plan sponsor also may increase the ADP and the ACP of non-highly compensated employees (NHCEs) by adding a matching contribution or increasing the existing matching contribution formula. They can also solicit NHCE participation using a communication campaign or an automatic enrollment feature. 

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Mid-year safe harbor adoption

Problem: The employer wants mid-year adoption of an ADP or ACP safe harbor plan design for the current plan year to prevent HCE deferral refunds or additional employer contributions in the current year.
Types of plans affected: 401(k) and 403(b)


Unfortunately, adopting this provision mid-year isn’t an option. It must be in place for the entire plan year. Current rules won’t allow a 401(k) or a 403(b) plan with ongoing deferral contributions to be amended midyear to add safe harbor provisions. Such a plan design change must be made before the first day of the plan year. 

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Failure to forward payments

Problem: Failure to forward employee elective deferral contributions or loan payments to the plan trust in a timely manner
Types of plans affected: 401(a), 401(k) and 403(b)


Failure to promptly deposit employee elective deferrals is a prohibited transaction under the Employee Retirement Income Security Act of 1974 (ERISA), which requires Form 5500 reporting and, potentially, payment of excise tax. For non-ERISA plans, the plan document may contain provisions relating to this issue.


Make sure all employee elective deferral contributions and loan payments are deposited as soon as possible after payrolls and deferrals are processed. Make the timing of these deposits as consistent as possible throughout the year. The Department of Labor’s Voluntary Fiduciary Correction (VFC) program addresses late elective deferrals for plans subject to ERISA.

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Failure to limit elective deferrals

Problem: Failure to limit elective deferrals following a hardship distribution (when safe harbor hardship rules apply)
Types of plans affected: 401(k) and 403(b)


Failure to suspend elective deferrals, if required, is a plan operational error that requires corrective action.  


Review the hardship provision in the plan document to identify whether safe harbor or facts and circumstances is used as the determination criteria. If the document uses the safe harbor hardship definition, the plan sponsor must ensure that employee elective deferrals and other employee contributions to all employer plans are stopped for six months following the hardship distribution.


Please note: Most plans elect to apply safe harbor hardship rules.

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Top-heavy 401(k)

Problem: A new 401(k) plan is top-heavy in its first year, or an existing plan is top-heavy for the first time, and the employer isn’t prepared to make the required top-heavy employer contribution.
Types of plans affected: 401(a) and 401(k)


If a plan is top-heavy, the employer must contribute up to 3% of compensation for all non-key employees who are employed on the last day of the plan year.


Don’t assume that employer contributions won’t be required. To avoid a top-heavy situation, a plan may exclude key employees from participation or may reduce key employee elective deferrals and employer contributions. A top-heavy plan that’s designed as an ADP or an ACP safe harbor plan may be exempt from top-heavy rules or may satisfy the top-heavy required contribution using a safe harbor contribution.  


Contact your Lincoln representative to see how we can help your clients meet their retirement plan design and operational needs.

Lincoln Financial Group® affiliates, their distributors, and their respective employees, representatives and/or insurance agents do not provide tax, accounting or legal advice.  Please consult an independent advisor as to any tax, accounting or legal statements made herein.

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