When an auditor or compliance reviewer writes that plan procedures were not followed, the finding means the retirement plan was run in a way that didn’t match its own governing document. Every qualified plan has a written rulebook covering eligibility, contributions, vesting, distributions, and loans, and ERISA judges compliance by comparing what that document requires against what actually happened. A gap between the two is an operational failure, and it has to be corrected regardless of whether anyone acted in bad faith.
Most of these findings start with something ordinary. A payroll administrator misreads a waiting period. A new HR manager doesn’t realize the plan excludes bonuses from the definition of compensation. Someone processes a distribution without checking the vesting schedule. None of it involves an attempt to cheat the system, but all of it counts as a failure that regulators expect to be fixed.
What Counts as a Procedure Failure
The IRS keeps a running list of the mistakes it sees most often in 401(k) plans, and a handful of categories dominate.1Internal Revenue Service. 401(k) Plan Fix-It Guide
- Excluding eligible employees. A plan may require six months of service before deferrals can start, but payroll waits a full year. The affected workers missed months of contributions they were entitled to make.
- Using the wrong definition of compensation. If the document excludes overtime or bonuses and the administrator includes them (or the reverse), every affected contribution is calculated on the wrong base.
- Skipping or miscalculating employer matching contributions when the formula isn’t applied consistently.
- Exceeding participant loan limits. Federal law caps plan loans at the lesser of $50,000 (reduced by the highest outstanding balance in the prior year) or the greater of 50% of the vested balance or $10,000. A loan over that ceiling becomes a taxable deemed distribution.2Internal Revenue Service. Deemed Distributions – Participant Loans
- Ignoring the vesting schedule when paying out a departing employee.
- Late deposits of employee contributions. Employers must deposit withheld deferrals as soon as those funds can reasonably be separated from company assets, and no later than the 15th business day of the following month. Plans with fewer than 100 participants get a safe harbor if deposits arrive within 7 business days of the payroll date.3U.S. Department of Labor. FAQs About Retirement Plans and ERISA
The common thread is that the document says one thing and the operation did another. Good judgment is not a defense. If the written plan requires a particular step, that step is what fiduciaries have to follow.
Why It Matters: Fiduciary Duty and Disqualification
ERISA Section 404(a)(1)(D) requires fiduciaries to run the plan according to its written terms. When a breach causes losses, the Department of Labor can pursue recovery and then assess a civil penalty equal to 20% of whatever amount is recovered through settlement or court order.4Office of the Law Revision Counsel. 29 USC 1132 – Civil Enforcement The penalty can be waived if the fiduciary acted reasonably and in good faith, or if paying it would cause severe financial hardship, but the default expectation is personal accountability: fiduciaries restore losses from their own pockets, and the penalty is added on top.
The worst-case outcome of an uncorrected failure is plan disqualification, and the tax fallout spreads to everyone involved. Employer contributions to a disqualified plan are no longer currently deductible; the deduction is deferred until the contributions appear in employees’ taxable income, which may be years later. For defined benefit plans without individual accounts, the deduction may be lost entirely.5Internal Revenue Service. Tax Consequences of Plan Disqualification
Employees generally must include any vested employer contributions from the disqualified years in gross income. Highly compensated employees face a harsher rule: if the plan failed coverage or participation requirements, they may have to include the entire vested account balance in that year’s income. Distributions from a disqualified plan cannot be rolled over to an IRA or another qualified plan, so the money is taxed on the way out with no rollover relief. The trust itself loses its tax-exempt status, meaning investment earnings become taxable, and employer contributions to a nonexempt trust trigger FICA and FUTA that wouldn’t otherwise apply.5Internal Revenue Service. Tax Consequences of Plan Disqualification
Disqualification is rare in practice because the IRS built a correction system specifically to keep failures from getting that far. Understanding the ceiling helps explain why regulators take procedural drift seriously.
How to Fix It: The EPCRS Programs
The Employee Plans Compliance Resolution System is the IRS framework for correcting operational failures. It has three tracks, and which one applies depends on how the failure was discovered and how significant it is.6Internal Revenue Service. EPCRS Overview
Self-Correction Program
Self-correction is free and requires no IRS filing. Insignificant operational failures can be self-corrected at any time. Significant failures traditionally had to be corrected by the end of the third plan year after the year the failure occurred.7Internal Revenue Service. Self-Correction Program (SCP) FAQs
SECURE 2.0 widened this door considerably. For “eligible inadvertent failures,” meaning those that occurred despite reasonable practices and procedures and aren’t egregious or tied to asset misuse, the correction period is now indefinite.8Internal Revenue Service. Notice 2023-43 – Guidance on Section 305 of the SECURE 2.0 Act The IRS can still step in if it finds the failure before the sponsor shows a commitment to fixing it.
Voluntary Correction Program
When a failure is too complex for self-correction, or when the sponsor wants formal IRS sign-off, the Voluntary Correction Program requires a written submission and a user fee tied to plan assets, ranging from $2,000 for smaller plans up to $4,000 for plans over $10 million in net assets.9Internal Revenue Service. Voluntary Correction Program (VCP) Fees In exchange, the sponsor receives a compliance statement confirming the correction is acceptable and the plan’s qualified status is preserved. This option closes once the IRS opens an examination.
Audit Closing Agreement Program
If auditors find the errors first, the Audit Closing Agreement Program is the remaining path. The sponsor negotiates a monetary sanction based on the severity of the failure and the tax impact that would have followed full disqualification. The sanction is at least as much as the VCP fee would have been, and often significantly more.6Internal Revenue Service. EPCRS Overview Delay is what makes correction expensive.
Corrective Contributions for Missed Deferrals
When an eligible employee was left out and missed the chance to defer, the standard correction is a Qualified Nonelective Contribution from the employer equal to 50% of the missed deferral. The missed deferral is calculated by multiplying the average deferral percentage for the employee’s group (highly compensated or not) by that employee’s compensation for the year.10Internal Revenue Service. 401(k) Plan Fix-It Guide – Eligible Employees Weren’t Given the Opportunity to Make an Elective Deferral Election
If the excluded employee is still working and certain timing conditions are met, the corrective contribution drops to 25% of the missed deferral. For plans with automatic enrollment, the corrective QNEC can be reduced to zero when correct deferrals begin within 9½ months after the end of the plan year in which the failure occurred and the affected employee receives notice within 45 days. The employer also has to make any matching contributions the employee would have received, and the plan must restore lost earnings on whatever amount should have been in the account.
Late Deposits Are a Separate Problem
Late deposits of employee contributions trigger consequences from two agencies at once. The DOL treats commingled deferrals as a prohibited use of plan assets. The IRS can impose an excise tax of 15% of the amount involved for each year the prohibited transaction goes uncorrected, and that jumps to 100% if it still isn’t fixed after the IRS identifies it.11Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
The DOL’s Voluntary Fiduciary Correction Program is the fix. The employer deposits the missing contributions plus lost earnings calculated with the DOL’s online calculator. Where lost earnings total $1,000 or less, a self-correction component allows the fix without a full VFCP application, provided deposits are made within 180 days of the original withholding date.12U.S. Department of Labor. Fact Sheet – Voluntary Fiduciary Correction Program Employers who complete the VFCP process and receive a no-action letter also qualify for an exemption from the excise taxes.
Document and Report the Correction
A correction isn’t complete without a paper trail. Plan sponsors should document what the failure was, when it started, how it was found, and exactly what steps were taken to fix it. Those records are the defense in any future audit.
Late deposits of employee contributions must be reported on Form 5500, filed jointly with the DOL and IRS. The form requires disclosure of the total delinquent contributions, and the amount must be reported again in each subsequent year until the violation is fully corrected with lost earnings restored.13U.S. Department of Labor. 2025 Instructions for Form 5500-SF The reporting obligation is how regulators verify that participants are being treated according to the plan’s terms, which is the same standard that “plan procedures not followed” measures against in the first place.