Do you treat 401(k) testing as a secondary, last minute task? If you understood what happens when a plan fails 401(k) testing, you wouldn’t want to put it off. While simple if caught in advance, leaving testing to last minute could result in unintended consequences. Take a minute to go beyond the technical jargon and complex calculations to the personal and professional fallout of failed 401(k) testing.
Delivering Bad News to Your Star Employee
Malik has been one of Sean’s top sales performers and a close friend for the last 15 years. He was by Sean’s side when he lost his mom. Now nearing retirement, Malik has been maxing out his 401(k) contributions. He’s excitedly planning a long-awaited trip to Paris with his spouse and dreaming of teaching his grandkids how to fish.
Now Sean’s hands are sweating as he walks towards Malik’s office. The business failed Actual Deferral Percentage (ADP) testing. Because Malik is a highly compensated employee (HCE), the business has to return a portion of his 401(k) contributions, including any earnings. This means Malik has additional taxable income he didn’t plan for and has a large, unexpected lump sum he will have to pay. Sean gulps and knocks on Malik’s door.
While Malik tries to remain professional, his frustration is visible. “I put that money away specifically to fund retirement for Susie and me,” he says. “I’ve been with you for so long. How could you let this happen?”
Putting a Pause on Expansion
It’s been a stellar year for Sharon’s construction business. In fact, it’s having its highest grossing year on record. She might finally be able to expand, hire some new staff and maybe get ready to open a new location. All her hard work is finally paying off.
Sharon splurges and treats herself to an expensive restaurant. Each bite feels like success.
When she logs in to work the next day, Sharon opens an email from her 401(k) provider. She failed her Actual Contribution Percentage (ACP) testing! It seems she didn’t encourage her no-highly compensated employees to contribute to their 401(k) plans. If Sharon doesn’t act soon, her 401(k) plan could lose its tax-qualified status. Flabbergasted, she researches what this means for her business. Now those extra gains she celebrated will need to go to the non-highly compensated employees (NHCEs) and she will have to go through the hassle of testing again. Head in her hands, Sharon takes a deep breath. Her new priority is ensuring this never happens again.
Letting Down a Mentor
Michael has been leading the family business for the last year, ever since his grandfather stepped down. After years of shadowing and being guided by his grandfather, Michael has finally proven himself ready to fully steer the ship.
One of his first steps was to implement a 401(k) plan. It’s been a roaring success. Everyone loves the new benefit, the business has enjoyed the tax breaks, and he has even been able to convince some of his younger cousins to join the family business because of it.
Now Michael is frantically researching what to do if you fail Top-Heavy Testing. He’s been alerted that 60% of the assets in the plan are owned by key employees. To correct the mistake, Michael must now make a 3% contribution to everyone else’s accounts. It’s an unexpected financial headache with a large sum attached. This slows down the business’ planned expansion and hiring. Michael is not looking forward to explaining this oversight to his grandfather.
How to Prevent Failure
Failing 401(k) compliance testing has very real, very stressful consequences.
That’s why at 401GO, we make sure compliance failures don’t come out of the blue. Thanks to our continuous, automated health reports, you’ll be notified the moment an issue arises. This gives you the time you need to course correct before the real end-of-year testing.
If you want to prepare your plan now for testing, 401GO is here to help. Reach out to see how we can protect your business.
