What happens if you have a payroll correction and need to reverse 401(k) contributions?

There are several reasons why a plan administrator might need to run a corrective payroll or payroll adjustment that affects 401(k) contribution amounts. Usually, when contributions are made to a 401(k) plan they cannot be withdrawn, even when a payroll reversal happens. Instead they are put into an unallocated account inside the plan, where they can be used to offset future costs and contributions, as long as your plan allows for these payments.

Reasons for reversing 401(k) contributions might include:

  • An employee was enrolled in the plan before meeting eligibility requirements
  • Deferrals were withheld from the wrong employee’s pay
  • Payroll was processed  with the wrong date or amount. Contributions were calculated using the wrong compensation amounts. Review what types of compensation must be included in the calculation of 401(k) contributions in this article

The IRS does not allow payroll reversals to correct the following: 

  • 401(k) plan testing failures including annual compliance testing failures and annual employee contribution limit failures
  • Contributions made via autoenrollment. See this article for more information.

If you have specific concerns governing your individual situation, you should reach out to your CPA or tax professional to determine what steps you should take in order to remain in compliance with the laws and regulations. 

A very limited exception exists where a “mistake of fact” has occurred (e.g. mathematical and typographical errors), which resulted in incorrect contribution amounts. Learn more about “mistake of fact” errors in this article.

What happens to the funds once they are reversed by Guideline?

Guideline will apply reversed funds to an unallocated account inside the plan trust.  That balance can be used as a credit against future ACH collections under the terms of your plan. As the employer, you won’t receive earnings on the mistaken contributions, and you will bear any potential market losses on the funds that are reversed. On your “Confirmation of Withdrawal” email, you may see contributions being debited from "plan cash" instead of "from bank," as we will deplete any outstanding eligible funds in the “plan cash” balance before withdrawing from your bank account. The withdrawal source is also notated in the contribution report section under the “reports” tab of your Guideline administrator account. You can read more about this in the Guideline Terms of Service.

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