Certified Plan Sponsor Professional (CPSP) Practice Exam

Which of the following is a common failure related to 401(k) plans as noted by the IRS?

1. Overestimating contributions

2. Providing excessive loan options

3. Failure to follow the plan's definition of compensation

4. Exceeding contribution limits

The correct answer is: Failure to follow the plan's definition of compensation

One of the common failures related to 401(k) plans, as noted by the IRS, involves not adhering to the plan’s defined compensation structure. Each 401(k) plan specifies how compensation is defined for the purposes of contributions, and any deviation from this defined structure can lead to discrepancies in contributions for employees. For instance, if a plan allows for a broader interpretation of compensation than what is defined, it may result in excessive contributions or benefits for certain employees, creating compliance issues. This issue highlights the importance of clearly outlining and consistently applying the definition of compensation as stated in the plan documents. Proper adherence ensures equitable treatment of all participants and compliance with regulatory guidelines. When plans do not follow their own definitions, it can lead to complications such as refunding excess contributions and other corrective actions required by the IRS, which can be costly and time-consuming for employers. In relation to the context of the other potential failures: overestimating contributions pertains to inaccurate forecasts or employee behavior, providing excessive loan options can lead to participant financial strain but may not be classified as a regulatory failure, and exceeding contribution limits is indeed a common mistake but is distinct from the specific complications arising from misinterpretations of compensation definitions.