One of the surest ways to sow discord among employees is to cause them to have a large unexpected tax bill. This type of blunder will likely get a similar response to not making payroll. The maintenance of the tax exempt status of 401(k)’s requires some effort but prompt and appropriate action will prevent an unwanted exodus of personnel. The following mentions common plan issues that have tax implications and some useful tips for staying out of trouble.
Regularly Use Forfeitures
Forfeiture accounts should have a zero balance at least annually. The ideal use of forfeitures is to reduce employer contributions. Other acceptable uses include an additional contribution or plan expense payments. Regardless, the plan document governs the use and may even differentiate the type of forfeiture (forfeiture of employer match vs. forfeiture of employer discretionary, etc.). Trouble comes when forfeitures are used in a manner inconsistent with the plan document or when used to pay for unreasonable plan expenses (ex: a Hawaiian vacation for the plan sponsor).
Check back next week for Part 2 of the series.