How to Handle a Missed 401(K) Deduction From an Employee’s Pay

Identify and Document the Error

Spot the Problem Early

• Check Payroll Records: Compare the employee’s 401(k) election against actual deductions for each affected pay period.
• Confirm Contribution Percentage: Make sure your system matches the percentage or dollar amount the employee elected.
• Gather Evidence: Note the dates of missed deductions, the amounts involved, and any relevant communications or plan documents.

Keeping a clear record of each issue will be crucial if you need to prove compliance or correct plan data later.

Notify the Employee and Explain Next Steps

Communicate Promptly

• Share the Details: Inform the employee about the pay periods involved, the amount missed, and how you plan to correct it.
• Offer a Timeline: Let them know when the correction will appear on their paycheck or in the retirement plan.
• Encourage Questions: Make yourself available to address concerns about compound interest, tax implications, or plan matching.

Honesty and clarity maintain trust. When employees see you’re proactive, they’re more likely to stay confident in the company’s retirement plan administration.

Calculate the Correct Contribution and Any Missed Earnings

Determine What’s Owed

• Principal Contribution: Figure out how much should have been withheld from the employee’s pay based on their election.
• Employer Matching: Calculate any match that would have applied if the deduction had been processed correctly.
• Lost Earnings: Use plan guidelines or a Department of Labor-approved method to estimate gains or losses for the missed contributions during the affected period.

Make sure these calculations align with your plan’s rate of return or the average investment performance over the relevant timeframe. Additionally, maintaining accurate record-keeping is crucial for demonstrating compliance if you’re audited.

Adjust the Next Payroll (or Issue an Off-Cycle Check)

Process the Makeup Contribution

• Withhold Corrected Amounts: Decide whether to deduct the missed contributions in one sum or spread them across several paychecks, depending on plan rules and the employee’s preference.
• Add Employer Match and Earnings: Contribute any matching funds and calculated lost earnings to the employee’s account.
• Keep Documentation: Store records of each makeup contribution and provide the employee with an updated pay stub or benefit statement.

Act promptly to ensure the correction is handled in the same tax year whenever possible, simplifying tax reporting for both parties.

Update Plan Records and Coordinate with Plan Administrators

Maintain Accurate Documentation

• Notify Your Plan Administrator: Submit the necessary correction data, including updated contribution and matching figures.
• Confirm Plan Acceptance: Request written confirmation that the plan has recorded the makeup contributions correctly.
• Review Compliance: Consult with HR or a legal advisor if you’re unsure about IRS or Department of Labor rules for corrected 401(k) contributions.

Keeping your plan administrator in the loop helps ensure that all records match and the employee’s retirement account reflects the accurate balance.

Prevent Future Errors

Implement Safeguards

• Regular Audits: Conduct quarterly or monthly spot-checks of payroll against 401(k) elections to catch discrepancies early.
• Automated Alerts: Use system triggers that flag missing or unexpectedly low deductions.
• Training for Payroll Staff: Ensure your team knows how to process 401(k) changes and recognizes common errors.
• Clear Employee Guidance: Encourage employees to review each pay stub to confirm that 401(k) contributions are accurate.

A proactive approach reduces the risk of repeated oversights that can erode employee confidence and create compliance headaches. If your team is stretched thin, consider outsourcing payroll to gain access to a dedicated team focused on keeping payroll accurate and compliant.

Frequently Asked Questions

Does a Makeup Contribution Affect the Employee’s Tax Return?
A missed contribution typically affects the current tax year. Once you process the corrected amount, it’s treated as if made within the current year—unless special provisions apply. Consult a tax professional if you have questions about prior-year adjustments.

What If Adding the Missed Amount Exceeds 401(k) Limits?
If your correction risks pushing the employee over the annual deferral limit, coordinate with your plan administrator to handle the excess. They may need to return any surplus, along with earnings, to keep the plan compliant.

Do We Need to Include Extra Interest?
Yes. Under Department of Labor guidance, employers typically add “lost earnings” to ensure the employee’s account is in the same position it would have been if the error never occurred.

How Long Should Records Be Kept?
Retain all payroll and plan records for at least six years, but check your state’s retention requirements and your plan documents for specific guidelines.

Is Fiduciary Insurance Necessary?
While not required, fiduciary liability insurance helps protect against losses from plan administration errors. It covers legal fees or claims if your 401(k) management is challenged.

Conclusion

Christina

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