As a plan sponsor, you're responsible for depositing both employee and employer contributions into your 401(k) plan on time. Employee contributions have the shortest deadlines and need to be deposited as soon as they can reasonably be separated from your business's assets. If deposits are late, you may owe employees additional funds called lost earnings. This article explains how late deposits, missed deferrals, and lost earnings penalties work.
A late deposit happens when employee deferrals or 401(k) loan payments are properly withheld from pay but are not deposited into the 401(k) plan on time.
The deadline is as soon as the contributions can reasonably be separated from your business's assets. Small plans with fewer than 100 participants have a seven-business-day safe harbor — deposits made within seven business days after the pay date are not considered late. Gusto Retirement uses five business days for plans with 100 participants or more.
A late deposit is considered a prohibited transaction under Internal Revenue Service (IRS) and Department of Labor (DOL) rules. The agencies view the employer as keeping employee funds for their own purposes during the period the deposits are late. The funds reduce an employee's paycheck and, as of the date of that paycheck, are owned by the employee — not the employer (unlike employer contributions).
Late deposits need to be reported on the plan's Form 5500. A 15% excise tax will also be applied to the amount of the lost earnings and reported on Form 5330.
Note: The DOL also provides the Voluntary Fiduciary Correction Program (VFCP) to correct late deposits. However, the process is optional and more complex. Gusto Retirement uses the IRS method and Form 5330 filing to correct the late deposit prohibited transaction, but does not separately file the correction under the VFCP.
Monitor your plan contributions regularly and make sure deposits happen as quickly as possible. If your Gusto or Gusto Embedded payroll and 401(k) accounts are connected but deductions did not occur from a recent payroll run, it may be the result of an error. In that case, check your 401(k) dashboard for a payroll reconnection task.
Late deposits only apply when a deferral or 401(k) loan repayment is withheld from an employee's pay and there is a delay in depositing that contribution into the plan. If your plan fails to withhold deferrals from an employee's pay when it should have, it is considered a missed deferral opportunity.
Depending on the timing of the correction and other factors, a missed deferral opportunity may require a correction involving Qualified Non-Elective Contributions (QNECs). QNECs are employer contributions that are always 100% vested. Because the employees already received the pay where the deferral should have been deducted, the IRS limits the QNEC to no more than 50% of the missed deferral amount. In some cases, the QNEC can be 25% of the missed deferral or not required at all.
When the QNEC is required, lost earnings also need to be calculated because the QNEC takes the place of the missed deferral. Lost earnings for the QNEC are calculated using the original payroll date where the deferral should have been applied.
Employer contributions have deadlines that vary based on the type of contribution. The deadline can also be specified in your plan document.
There are two possible deadlines that could apply to employer contributions with us:
Safe harbor matching contributions where the plan document specifies contributions are made per pay period (most Gusto 401(k) plans) need to be contributed by the end of the plan quarter following the plan quarter where the payroll took place. For example, if the plan year ends on Dec. 31, the latest deposit date for safe harbor matching contributions for a Jan. 15 payroll is the last day in June.
All other employer contributions generally need to be deposited no later than the time prescribed by law for filing the employer's federal income tax return for the fiscal (or taxable) year with or within which the plan year ends, including any requested extensions.
If employer contributions are deposited after the applicable deadline, lost earnings apply to the contribution.
Lost earnings amounts are calculated based on four factors:
Amount of the late contribution.
Date the contribution was due or the deferrals were withheld from participants' paychecks (pay date).¹
Date the contribution was deposited in the plan's trust account.
The earnings on investments for the affected participant during the period between the date the contribution was due and the date it was actually contributed.
Once the late contributions are collected, we calculate and attribute lost earnings to each affected participant's account. These corrective contribution amounts will be charged to your company bank account.
If the late contribution is a late deposit of employee contributions, you will typically owe excise taxes. We will prepare a Form 5330 on your behalf and notify you once it is available in your Resource Library. The excise tax is calculated as 15% of the lost earnings owed. It is your responsibility to sign, file, and submit payment for the excise taxes to the IRS directly.
¹ In some cases, Gusto Retirement uses the pay date to determine late deposits. If payroll is backdated or processed after the pay date, it may result in late deposits.