401(k) Fix-It Guide: Plan Operations and Terms

401(k) Fix-It Guide

You didn’t base the plan operations on the terms of the plan


Find the Mistake

Fix the Mistake

Avoid the Mistake

2) You didn’t base the plan operations on the terms of the plan document. Failure to follow plan terms is a very common mistake. Conduct an independent review of the plan document provisions compared with its operation. Apply reasonable correction method that would place affected participants in the position they would’ve been in if there were no operational plan defects. Develop a communication mechanism to make all relevant parties aware of changes on a timely and accurate basis (best practices). Perform a review at least annually to ensure that you’re following plan terms.

The plan sponsor/employer is responsible for keeping the plan in compliance with the tax laws; however, there may be many employees, vendors and tax professionals servicing your plan.

You should convey any changes made to your plan document or to your plan’s operation to everyone who provides service to your plan. For example, if you amend your plan document to change the definition of compensation, you should communicate that change to everyone involved in determining deferral amounts withheld from employee pay, performing your plan’s nondiscrimination tests or allocating employer contributions. Also, if you decide to use a different definition of compensation in operation, make sure you amend the plan timely to reflect that change.

Below are some common changes requiring due diligence to identify any potential mistakes:

  • If you made changes to your plan document, inform everyone who services your plan of those changes and what the changes mean to your plan’s operation.
  • If you amend your plan document, you should also amend your summary plan description. If you materially modify your plan, you must give a summary of the material modifications to plan participants within 210 days after the end of the plan year in which you adopted the modification.
  • If you’ve changed the way you operate your plan, communicate those changes to everyone who provides service to your plan. You may need to reflect these changes to your plan document through a plan amendment.
  • If you’ve changed the plan trustees, you need to convey those changes and you may need to update your plan document and summary plan description.
  • Any changes in the ownership interests or business acquisitions may affect the nondiscrimination testing for the plan. Convey these changes to your plan service providers.

How to find the mistake:

You must be familiar with your plan document to be able to determine if you’ve operated it according to its terms. Following the plan document terms is crucial to ensure tax-favored treatment of the plan and to prevent a breach of fiduciary duty under ERISA. Be familiar with the plan document wording and how it affects the plan operation. Conduct an independent review of your plan and its operation annually. If you operate your plan using a summary, check the requirements and definitions on that sheet to make certain they correspond to the plan document. Consider conducting a 401(k) plan check-up using the 401(k) plan checklist.

Corrective action:

If you find an error in the operation of your plan, correct it as soon as possible. Use a reasonable correction method that places affected participants in the same position they would have been in had the mistake not occurred. Revenue Procedure 2016-51, section 6 provides general correction principles you should use in determining an appropriate correction method. If you correct a mistake listed in Appendix A or Appendix B of Revenue Procedure 2016-51 according to the correction methods provided, you may be certain that your correction is acceptable.


Employer A’s 401(k) plan provides for employer matching contributions of 50% of the deferrals made to the plan, up to the first 6% of compensation. The plan provides that these employer-matching contributions vest at the rate of 20% per year. Net plan assets reported on the most recently filed Form 5500 are less than $500,000. A participant must work at least 1,000 hours in a calendar year to receive vesting credit for that year. Bob participated in the plan from January 1, 2011, to September 30, 2014, when he terminated employment. Bob worked 2,000 hours in 2011, 2012 and 2013, and during 2014, the year of termination, Bob worked 1,100 hours. At termination, Employer A paid Bob his plan benefits in a lump sum. At that time, Bob’s employer matching contribution account balance was $5,000. Employer A calculated Bob’s vested percentage as 60%, 20% for each of the three full calendar years he was employed. Bob was paid $3,000 from his employer matching contribution account.

A mistake has occurred because Employer A should’ve credited Bob with a vesting year of service for 2014 since he worked in excess of 1,000 hours in that plan year. Bob should’ve been 80% vested for the four years of vesting service.

Reasonable correction:

Employer A must make a corrective distribution to Bob to correct the vesting mistake. Employer A should credit Bob with an additional 20% of the account balance of $5,000, or $1,000, plus any additional earnings from the date of the original distribution to the date of the corrective distribution.

Correction programs available:

Self-Correction Program:

The example illustrates an operational problem, because Employer A didn’t follow the plan terms by improperly vesting Bob’s account. If the other eligibility requirements of SCP are satisfied, Employer A may use SCP to correct the mistake.

  • No IRS imposed fees for self-correction.
  • Practices and procedures must be in place.
  • If the mistakes are significant in the aggregate:
  • Employer A needs to make corrective contribution to the plan and have the Plan make a distribution to Bob by December 31, 2016.
  • If not corrected by December 31, 2016, Employer A isn’t eligible for SCP and must correct under VCP.
  • If the mistakes are insignificant in the aggregate, Employer A can take corrective actions to fix the mistake beyond the two-year correction period for significant errors. Whether a mistake is insignificant depends on all facts and circumstances.

Voluntary Correction Program:

Correction is the same as described above under SCP. If the plan is not under audit, Employer A makes a VCP submission according to Revenue Procedure 2016-51. The 2018 user fee for most VCP submissions is $1,500 given the amount of net plan assets. If the amount of net plan assets exceeds $500,000, the user fee is higher. VCP user fees may change in subsequent years. When making the VCP submission, A must include Forms 8950 and 8951 and consider using the model documents set forth in the Form 14568 series.

Audit Closing Agreement Program:

Under Audit CAP, correction is the same as described above under SCP. Employer A and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction The sanction under Audit CAP is based on facts and circumstances, as discussed in Section 14 of Revenue Procedure 2016-51.

How to avoid the mistake:

  • Be sure to apply the provisions of the plan correctly when making a determination of what contributions or benefits are provided to participants. Develop a way to communicate changes timely and accurately to plan administrators and outside service providers (outside plan consultant, actuary and/or third party administrator/record keeper).
  • Have a clear process for making distributions. This process should include the plan procedures for ensuring appropriate authorization, accuracy and timeliness. Identify a team responsible to oversee payments.
  • Establish protocols and an action plan to use when errors are identified including the appropriate actions to resolve the errors.
  • Identify the plan trustees as well as the procedures for tracing cash contributions and agreed-to receipts by the trust custodian.
  • Clearly identify the custodian of trust assets including procedures for maintaining trust asset data, communication mechanisms for transferring trust asset data to the trustee, and the reconciliation process including how to deal with errors.


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