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When Employer Contributions Go Wrong in 401(k) Plans

Authored by Matt Waters

Employer contributions are one of the most valuable parts of a 401(k) plan. They’re also one of the easiest areas for mistakes. Whether it’s a match, profit-sharing, or safe harbor contribution, the IRS and Department of Labor expect absolute precision. When the math, or the rules, go sideways, the result is compliance failures, costly corrections, and sometimes angry employees.

Here’s what every plan sponsor needs to know.

Common Ways 401(k) Contributions Go Wrong

1. Wrong Compensation Definition

  • The plan document defines “eligible compensation” (it might include bonuses, overtime, or commissions).
  • Many payroll systems use a different definition, leading to under- or over-contributions.

2. Missed or Misapplied Matches

  • An employee contributes but doesn’t receive the correct match due to an administrative error.
  • Sometimes employers apply the wrong formula (e.g., 50% up to 6% instead of 100% up to 4%).

3. Ineligible Employees Included/Excluded

  • Contributions given to employees who aren’t eligible, or withheld from those who are.
  • New hires and part-timers are common trouble spots, especially under the updated SECURE Act rules.

4. Profit-Sharing Allocation Errors

  • Contributions allocated inconsistently with the plan document (e.g., “pro rata” vs. “new comparability” formulas).

5. Failure to Follow Vesting Schedules

  • Giving too much credit (fully vested too early) or too little (denying vested amounts owed).

Correcting the Mistakes

The IRS requires sponsors to fix errors through the Employee Plans Compliance Resolution System (EPCRS). The method depends on the size and nature of the mistake:

  • Missed contributions: The employer generally must make a corrective contribution to the participant’s account, adjusted for lost earnings.
  • Over-contributions: The excess is removed or reallocated, again with earnings adjustments.
  • Improper vesting: Participants who were shortchanged must receive the additional vested balance they’re owed.

Time matters. The longer an error lingers, the more expensive the correction.

Strategies to Prevent Employer Contribution Errors

  1. Align Payroll and Plan Definitions

    • Audit payroll codes to ensure they match the plan document’s definition of compensation.
  2. Automate Where Possible

    • Integrate payroll with the recordkeeper to reduce manual entry errors.
  3. Use Checklists for Contribution Cycles

    • Before each funding, confirm: employee eligibility, correct formula, correct compensation base.
  4. Mid-Year Reviews

    • Don’t wait until year-end. Spot-check match and profit-sharing calculations during the year to catch problems early.
  5. Employee Communication

    • Encourage participants to check their statements and ask questions. Employees often spot mismatches faster than administrators.
  6. Regular Plan Audits

    • Work with a third-party administrator (TPA) or advisor to review contribution accuracy.

Bottom Line

Incorrect employer contributions may sound like a small administrative error, but the compliance and reputational risks are real. Every dollar in a 401(k) plan is held in trust for employees, and regulators take that responsibility seriously.

By aligning payroll with plan rules, automating processes, and proactively reviewing contributions, sponsors can prevent these errors before they become costly.

When in doubt, document everything, and partner with professionals who can help you get it right the first time.

 

This information does not constitute legal advice. Prime Capital Financial and its associates do not provide legal advice. Individuals should consult with an attorney regarding the applicability of this information for their situations.

Advisory products and services offered by Investment Adviser Representatives through Prime Capital Investment Advisors, LLC (“PCIA”), a federally registered investment adviser. Tax planning and preparation services are offered through Prime Capital Tax Advisory. PCIA: 6201 College Blvd., Suite 150, Overland Park, KS 66211. PCIA doing business as Prime Capital Financial | Wealth | Retirement | Wellness | Family Office | Tax Advisory.