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Updated: May 23, 2024

Keep the cash flowing by staying ahead of 401(k) contribution payments

Published By:

Billie Anne Grigg

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Missed 401(k) contribution payments can be a common small business bookkeeping and cash management oversight. Failure to make 401(k) contribution payments on time can lead to unwanted results for both the business and the business owner. That’s why it is important to understand 401(k) contribution payment requirements but also to have a strategy in place to make sure these payments are taken care of on time, every time.

 

Having worked as a bookkeeper for many years, there can be different causes for things to go awry. In this article, we will explore 401(k) contribution payments in detail, some of the most common reasons they aren’t made on time, the consequences of missed payments, how to correct them, and how to keep them from getting missed in the first place.

Why offer a 401(k)?

Access to a way to save for retirement is one of the top three benefits employees look for when looking for a new employer. Since the early 1980s, employers have increasingly turned to the 401(k) plan to provide these benefits.

 

Simply put, a 401(k) plan allows employees to defer some of their income on a pretax basis and deposit it into an investment plan. This helps employees lower their tax liability during their working years, usually resulting in overall savings in taxes over their lifetime. The deferred income, plus any earned dividends, provides the employee with income after retirement.

 

Although it’s not required, many employers match a certain percentage of employees’ contributions to their 401(k) plan. This matched amount is a business expense, which reduces the employer’s taxable profit.

 

In short, it’s a win-win-win.

  • A 401(k) provides employees with retirement benefits
  • It saves employees money on taxes
  • It can save your business on taxes

 

Now that we better understand why offering a 401(k) can have positives, let’s get into more detail what contribution payments owed has to do with this.

What does it mean to owe 401(k) payments?

In a nutshell, 401(k) contribution payments are managed as part of a company’s payroll process, and there is no bill or statement that comes in the mail reminding employers to make sure that these payments get made. Because of this, it’s easy for employers to overlook them.

 

The important thing to remember about 401(k) contributions is that, like withheld payroll taxes or collected sales taxes, the money is not your business’s money. It might feel like it is your business’s money because the cash is sitting in your company’s bank account. Paying the contribution might feel like an expense because cash is leaving the bank account, but keep in mind that 401(k) contributions are the property of your employees. You are simply holding these funds in trust for them until they can be deposited into the employee’s retirement plan.

 

Because you are acting as a fiduciary for your employees, you have a legal obligation to make your 401(k) contribution payments and make them “on time.” A fiduciary is a person or entity that is legally obligated to work in the best interests of another party whose assets or resources they are managing or overseeing. Making sure that these payments are handled promptly and properly comes with the territory.

 

  • For small plans with 100 or fewer participants, “on time” means within seven business days of the funds being withheld (within seven days of payday)
  • There’s no defined deadline for plans with more than 100 participants, but the “best practice” is to make the deposit on the same day the funds are withheld

 

To be clear, practically every business wants to make sure that these contributions end up where they are supposed to, but unintentional mistakes can happen.

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What are some reasons 401(k) contribution payments might be missed?

Throughout my bookkeeping career, I’ve seen numerous records with tens of thousands of dollars in retirement benefits sitting on the balance sheet. Although sometimes a simple bookkeeping error is to blame, more often than not the retirement benefits have never been paid. There are a few common reasons for this:

 

  • Running payroll in-house without software. When you only have a few employees and payroll seems simple, it can be tempting to manually take care of it. This is a mistake. If you choose to process payroll in-house instead of using a payroll company, at a minimum you should use payroll software that’s backed with technical support. This will ensure that your payroll, tax payments, and 401(k) contributions are made on time.
  • Not working with an experienced bookkeeper. Without fail, all of the businesses I’ve seen with unpaid retirement benefits weren’t working with an experienced bookkeeper. An experienced bookkeeper doesn’t only keep your financial records in tip-top shape, they are your best defense against common mistakes such as missed 401(k) contribution payments.
  • Cash flow problems and the absence of a cash management system. In all the cases of intentional nonpayment of 401(k) contributions that I’ve seen, the cause has been a lack of funds. Whenever the business owner has not been aware of the unpaid retirement benefits, the cash to make catchup contributions hasn’t been available because the money has been spent on other things. A solid cash management system can prevent both issues.
  • Events outside the business’s control. Sometimes, a 401(k) contribution is simply missed due to circumstances beyond the control of the payroll administrator. Whether it’s a natural disaster, an illness, a regional internet outage, or some other “act of nature,” if an event outside of your control causes you to miss a 401(k) contribution or delay it, having documentation of the circumstances could help you avoid the negative consequences of the missed or late payment.

 

What are the consequences of not making 401(k) contribution payments?

There can be some less-than-ideal outcomes when not making 401(k) contribution payments on time (or if a business fails to make them altogether), such as:

 

Fines and taxes

I mentioned earlier that when you have a 401(k) plan, you are acting as a fiduciary for your employees. This means that you are legally required to put your employees’ interests above your own, or those of your business. There are legal and financial consequences if you fail to do this.

 

Failure to make 401(k) contribution payments on time can result in the following fines and penalties:

  • Make up payments to cover the lost earnings AND earnings on those earnings. The Department of Labor has requirements for making your employees’ earnings whole when a failure to make 401(k) contribution payments on time results in lost earnings. These requirements include contribution into the plan of the lost earnings the employees would have realized.
  • This means that you not only have to make the 401(k) contribution payment you were originally supposed to, but you also must make up the difference between that contribution payment and the value of the market on the date you finally make the contribution payment. If the market has gone up, that can be a significant amount of money owed.
  • If enough time elapses between the date the contribution payment was supposed to be made and the date you finally make it, you might also have to pay into the plan any dividends the employees would have earned.
  • To put it simply, a late 401(k) contribution payment can easily cost your business thousands, or tens of thousands, of dollars in lost earnings payments.
  • 15% excise tax on lost employee earnings. On top of the lost earnings payments, you could also be on the hook for excise taxes in the amount of 15% of the lost earnings. The IRS imposes this penalty for each tax year in which the payments are missed.

 

If you’re thinking that you can fly under the radar on this step, think again. Form 5500, which is filed annually by the 401(k) plan administrator, reports late payments to both the IRS and the Department of Labor.

 

Criminal penalties

  • Don’t get mad at the messenger, but a breach of fiduciary responsibilities can carry criminal penalties, as well as financial ones. In addition to your business being on the hook for lost earnings and excise taxes, you could personally be liable for fines and subject to serve time in prison. This can happen if you are found guilty of a breach of fiduciary duties, or theft or embezzlement from your employees’ 401(k) plan.
  • You might be thinking, “I would never steal from my employees’ retirement plans!” But let’s say you take a draw or distribution from your business when you haven’t made your 401(k) contribution payments. In this scenario, you have now taken money that your business was holding in trust for your employees, and you have breached your fiduciary duties by not making required plan contribution payments.

 

It’s a slippery slope that you don’t want to find yourself on and one that most businesses can avoid.

 

Loss of employees’ trust

  • Last, but certainly not least, failure to make 401(k) contribution payments on time could take a toll on your employees’ trust. Many people in the workforce, especially those nearing retirement, keep a close watch on their portfolios. They will know if their retirement contributions aren’t being made as they should, and many may be unwilling to give you the benefit of the doubt. At best, you could lose a valuable employee. At worst, your business could find itself the subject of a lawsuit or a public scandal.

 

How can you fix missed payments?

If you owe past 401(k) contribution payments, your first step is to contact an accountant or a payroll specialist who can help you address the missed payments as soon as possible.

 

The internet will direct you to the Department of Labor’s Voluntary Fiduciary Correction Program (VFCP) to make up missed 401(k) contribution payments and the IRS’s Employee Plans Compliance Resolution System (EPCRS) to report missed payments and calculate excise tax due. While you will want to make missed payments as quickly as you can, doing so without the assistance of a payroll specialist or accountant could result in payment mistakes and further scrutiny.

 

In other words, act quickly, but don’t act without the guidance of a professional.

 

How can you prevent missed 401(k) contribution payments?

In every case of unintentional missed 401(k) contribution payments that I’ve seen, the missed payments could have been prevented with two simple mechanisms:

 

  • The assistance of a proactive, experienced bookkeeper. An experienced bookkeeper can tell from a glance at the balance sheet when retirement contributions aren’t being made on schedule. A proactive experienced bookkeeper will bring this matter to the attention of the business owner and encourage them to resolve it right away.
  • A cash management system. An effective cash management system will “impound” retirement contribution payments into a separate account until they are paid. This prevents the accidental spending of those funds on other business needs. In the event that payments are overlooked, the funds will be safely stashed away in the impound account, and the correction can be made without impacting the business’s cash position.

 

  • This same system can ensure that the business doesn’t get into a financial situation where it can’t make matching contributions. By proactively moving retirement contribution money into a separate bank account, the business owner can quickly determine if a cash flow crunch is looming and act accordingly.

 

Keep contributions payments top-of-mind

Offering a 401(k) plan provides your employees with a benefit that frequently sits at the top of their wish lists, while offering tax savings to them and to your business. However, when you have a 401(k) plan in place, you act as a fiduciary for your employees. This means that you are responsible for making contribution payments on time, every time. Failure to do so can result in financial and even criminal penalties.

 

Working with a reputable payroll company, a proactive and experienced bookkeeper, and implementing a cash management system will help you stay out of cash flow trouble with your 401(k) contribution payments and get you back to doing what you do best: running your business.

 

 

This article is for informational purposes only and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors for formal consultation.

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Billie Anne Grigg has been a bookkeeper since before the turn of the century (this one, despite what her knees seem to think). She is a Mastery Level Certified Profit First Professional and the Lead Technical Guide (coach) for the Profit First Professionals organization. She also frequently contributes to various small business and accounting industry publications.