Missed or late 401(k) contributions are a common bookkeeping and cash management oversight for small businesses. But failing to make these payments on time can lead to a Department of Labor penalty worth 20% of the amount recovered in a settlement, on top of IRS excise taxes.
What you’ll learn
What you’ll learn
Key takeaways
- A 401(k) plan is a highly requested employee benefit that can lower tax liability for both your team members and your business
- The IRS treats late deposits as a prohibited transaction, putting you on the hook for excise taxes, DOL penalties, and steep per-day filing fines
- Using an experienced bookkeeper and a cash management system helps you avoid accidentally spending retirement funds
That’s why it is important to understand 401(k) contribution payment requirements. Having a strategy to ensure you make these payments on time, every time, is the best way to avoid that risk.
These payments can slip through the cracks for several reasons. In this article, we cover 401(k) contribution payments in detail, including the most common reasons businesses miss them, the consequences of missed payments, how to correct them, and how to avoid missing them 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 this benefit.
A 401(k) plan lets employees defer some income on a pre-tax basis and deposit it into an investment account. This lowers their taxable income during their working years. The deferred income, plus any investment earnings, 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 savings and tax advantages
- It can save your business money on taxes through matching contributions and potential tax credits
But offering a 401(k) plan comes with the responsibility to ensure you deposit employee contributions on time.
What does it mean to owe 401(k) payments?
Companies generally manage 401(k) contribution payments as part of their payroll process. They don’t receive a bill or statement reminding them to make these payments, so it’s easy to overlook them.
The important thing to remember about 401(k) contributions is that, like withheld payroll taxes or collected sales taxes, the doesn’t belong to your business. It might feel like it does because the cash is in your company’s bank account, and paying the contribution might feel like an expense because the cash leaves your account. But once you withhold a 401(k) contribution from an employee’s paycheck, it legally becomes a plan asset. It’s your employees’ property, and you hold the funds in trust until you deposit them into their retirement plan.
Because you act as a fiduciary for your employees, you have a legal obligation to deposit these plan assets 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 manage or oversee.
If you hold on to plan assets longer than necessary, even unintentionally, the delay is a prohibited transaction, and it can trigger the penalties we’ll cover later in this article.
- For small plans with 100 or fewer participants, “on time” means within seven business days of withholding the funds (within seven days of payday).
- For plans with more than 100 participants, there’s no fixed safe harbor. The general rule is to deposit contributions as soon as you can reasonably segregate them from your business’s general assets. In practice, this often means within a few days of payday. The outer deadline is the 15th business day of the following month, but you’re at risk for penalties if you wait that long.
Business owners generally want to ensure these contributions end up where they’re supposed to, but unintentional mistakes can happen.
What are some reasons for late 401(k) contributions or missed payments?
It’s not unheard of to see tens of thousands of dollars in retirement benefit liabilities sitting on an organization’s balance sheet. Sometimes a simple bookkeeping error is to blame. More often than not, the business never sent the contributions to the plan. Here are a few common reasons this happens:
- 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 back by technical support. This helps ensure you make your payroll, tax payments, and 401(k) contributions on time.
- Not working with an experienced bookkeeper. Often, businesses with unpaid retirement benefits aren’t working with an experienced bookkeeper. An experienced bookkeeper doesn’t just keep your financial records in order. They’re your best defense against common mistakes like missed 401(k) contribution payments.
- Cash flow problems and the absence of a cash management system. Intentional nonpayment of 401(k) contributions usually comes down to a lack of available funds. A business owner might not realize the contributions are unpaid and spend the cash on other things. A solid cash management system can prevent issues.
- Events outside the business’s control. Sometimes a business misses a 401(k) contribution due to circumstances beyond the payroll administrator’s control, like a natural disaster, an illness, a regional internet outage, or some other unforeseen event. In that case, documenting the circumstances can help you avoid the negative consequences of a missed or late payment.
What are the consequences of not making 401(k) contribution payments?
There can be some less-than-ideal outcomes when you don’t make 401(k) contribution payments on time, or if you fail to make them at all, such as:
Fines and taxes
As mentioned earlier, when you have a 401(k) plan, you are a fiduciary for your employees. This means 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.
Failing 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 (DOL) requires you to make your employees’ earnings whole when a late contribution results in lost earnings. This means you must pay the original contribution amount, plus the difference between that amount and what it would have earned had it been deposited on time. If the market has gone up since the missed deposit, that difference can reach thousands of dollars.
- A 15% excise tax on lost employee earnings. Beyond make-up payments, the IRS treats late deposits as prohibited transactions, which triggers an excise tax equal to 15% of the amount involved for each year the contribution remains unpaid. If you don’t correct the issue, the IRS imposes an additional excise tax of up to 100% of the amount involved.
- A 20% DOL penalty on amounts recovered in a settlement or audit. If the DOL goes after you and recovers money through a settlement or court order tied to a fiduciary breach, it can assess a separate civil penalty of 20% of the recovered amount. The DOL waives the penalty if you self-correct through its Voluntary Fiduciary Correction Program (VFCP) before it opens an investigation.
- Steep per-day penalties for late or inaccurate filings. A 401(k) administrator must file Form 5500 annually. This tax filing reports late payments to both the IRS and the DOL. If you file it late or it contains inaccuracies, the DOL can assess a penalty of up to $2,739 per day with no cap. You calculate and pay the excise tax on late deposits using Form 5330, which has its own late-filing penalty of 5% of the unpaid tax per month, up to 25%.
Criminal penalties
- 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 face prison time. This can happen if a court finds you guilty of breaching your fiduciary duties, theft, or embezzlement from your employees’ 401(k) plan.
You might think, “I would never steal from my employees’ retirement plans!” But say you take a draw or distribution from your business when you haven’t made your 401(k) contribution payments. In this scenario, you took money your business held in trust for your employees and breached your fiduciary duties by not making required plan contribution payments.
It’s a slippery slope you don’t want to find yourself on, and one that most businesses can avoid.
Loss of employees’ trust
- Last but not least, failing to make 401(k) contribution payments on time takes a toll on your employees’ trust. Many workers, especially those nearing retirement, watch their portfolios closely. They know if their retirement contributions don’t hit their accounts on time. You could lose a valuable employee or even face a lawsuit or public scandal.
| Type of penalty/consequence | What it means for employers | Financial and legal impact |
| Make-up payments and lost earnings | The DOL requires you to pay the original contribution, plus any market earnings the employee missed out on | Can easily cost thousands of dollars, especially if the market rises during the delay |
| 15% to 100% IRS excise tax | The IRS treats late deposits as a prohibited transaction and taxes the amount involved | 15% per year the contributions remain unpaid, rising to 100% if not corrected |
| 20% DOL penalty | Assessed on amounts recovered through a settlement or court order tied to a fiduciary breach | Waived if corrected through VFCP before the DOL initiates an investigation |
| Late or inaccurate Form 5500 | The DOL can penalize unfiled or inaccurate annual reports | Up to $2,739 per day, with no cap |
| Criminal penalties | Failing to deposit funds is a breach of fiduciary duty. Using withheld funds for business expenses may constitute theft | Business owners can be held personally liable, facing severe fines or even prison time |
| Loss of employee trust | Employees monitor their retirement portfolios closely. Missing payments signals financial instability | High risk of losing top talent, public scandals, or facing employee-led lawsuits |
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.
A professional can help you navigate the DOL’s Voluntary Fiduciary Correction Program to make up missed contributions and lost earnings and avoid the 20% civil penalty. They can also help you file Form 5330 to report and pay excise taxes owed on the late deposit.
You want to make missed payments as quickly as you can, but doing so without the guidance of a payroll specialist or an accountant could lead to payment mistakes and additional penalties.
How can you prevent late 401(k) contributions or missed payments?
You can almost always prevent unintentional missed 401(k) contribution payments by taking the following steps:
- Work with a proactive, experienced bookkeeper. An experienced bookkeeper can tell with a glance at the balance sheet if you haven’t paid retirement contributions on schedule. They will bring this matter to the business owner’s attention and encourage them to resolve it right away.
- A cash management system. An effective cash management system “impounds” retirement contribution payments into a separate account until you remit them. This prevents you from accidentally spending those funds on other business needs. If you overlook a payment, the funds stay safely set aside in the impound account, and you can correct it without impacting the business’s cash position. This same system helps ensure the business doesn’t run into a cash flow situation where you can’t afford matching contributions. By proactively moving retirement contribution money into a separate account, you can quickly spot a looming cash flow crunch and act accordingly.
Keep contribution payments top-of-mind
Offering a 401(k) plan provides your employees with a benefit most employees value, while offering tax savings for them and your business. However, when you have a 401(k) plan, you act as a fiduciary for your employees. This means you’re responsible for making contribution payments on time, every time. Failing to do so can result in steep excise taxes, DOL penalties, and even criminal consequences.
Working with a reputable payroll company, a proactive and experienced bookkeeper, and a solid cash management system will help you stay out of trouble with your 401(k) contribution payments and let you focus on 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.