Avoiding Costly 401(k) Errors: What Business Owners Need to Know

A 401(k) Plan is an effective tool for business owners, big and small, to save for retirement, reward employees, and save on taxes. However, these plans have many complex parts, and mistakes can happen from time to time. Even though a mistake or missed tax filing may seem like a minor error, it can result in a costly correction or penalty from the Internal Revenue Service (IRS) or the Department of Labor (DOL). As such, working with a trusted Third Party Administrator (TPA) can help you reduce penalties or even avoid errors in the first place.

Common 401(k) Mistakes to Watch For

Because 401(k) plans involve ongoing compliance, reporting, and coordination across multiple parties, errors often arise in predictable areas. Identifying these common pitfalls can help business owners take a more proactive approach to plan administration. Below are several areas where mistakes commonly occur.

Missed Form 5500-EZ Filing for Owner-Only 401(k) Plans: One frequently overlooked issue involves owner-only 401(k) plans and the filing of Form 5500-EZ. Once total plan assets exceed $250,000 at the end of the plan year, a Form 5500-EZ is generally required. The standard late filing penalty is $250 per day, up to a maximum of $150,000 per late filing.

Setting up an owner-only 401(k) plan is very simple, and many business owners assume that the investment custodian will handle all of the tax filings. This is typically not the case.

Business owners should communicate with their CPA and financial advisor when establishing these plans and determine upfront who will be responsible for filing Form 5500-EZ when required. Working with a TPA can also help ensure plan balances are monitored annually and that the initial filing requirement is not overlooked.

Out-of-Date Plan Documents: Another common failure is failing to keep plan documents up to date. Most 401(k) plan documents are pre-approved by the IRS. As a result, IRS-required restatements, legislative changes, and optional amendments must be adopted on time for a plan to remain compliant. This is very common in owner-only plans, as electronic reminders the investment custodian to restate the document are ignored.

Another risk is operating under one set of rules while maintaining outdated plan documents, which can jeopardize the plan’s qualified status. Business owners should work with their TPA or ERISA counsel to regularly review and update plan documents as needed.

Excluding Eligible Employees: Eligibility mistakes remain one of the most common operational failures. Historically, many employers excluded part-time workers who should have been allowed to participate. This risk now includes Long-Term Part-Time employees (LTPTEs), who may become eligible after meeting statutory service requirements, as well as other part-time employees who satisfy the plan’s regular eligibility provisions. Employers that rely on outdated hour-tracking systems or manual processes may inadvertently omit eligible workers, creating missed deferral opportunities and required corrective employer contributions.

The employees responsible for plan administration should work closely with the TPA and Recordkeeper to understand the plan’s eligibility conditions and develop with processes and procedures to ensure that no eligible participant is inadvertently excluded from the plan.

New Highly Paid Individual (HPI) Roth Rule for 2026:  A new rule under SECURE 2.0 for 2026 is that participants who made over $150,000 of FICA Wages in the prior year must have any catch-up contributions treated as Roth, as opposed to pre-tax. While large payroll providers have systems programmed to assist plan sponsors in identifying these individuals and tracking their catch-up contributions, many smaller payroll providers and manual payroll processes may miss them. We suggest working with your TPA to identify these new HPIs and develop a process to prevent errors in the payroll process.

Next Steps for Reducing 401(k) Risk

Avoiding costly 401(k) errors often comes down to proactive administration and strong coordination with a trusted TPA. A successful plan depends on more than investment performance alone. It requires all components, including compliance, reporting, eligibility tracking, payroll coordination, and plan documentation, to work together effectively for the benefit of both the plan sponsor and employees.

CRI TPA Services can help business owners evaluate their plan administration processes, identify potential gaps, and strengthen compliance practices before issues become costly. Contact your CRI advisor to discuss how your organization can better support the long-term health of its 401(k) plan.