Payroll Integration: The 401(k) Feature That Prevents Costly Mistakes

Every pay period, a 401(k) plan depends on information moving from payroll to the recordkeeper: who got paid, how much, what each person deferred, loan repayments, new hires, and terminations. When that handoff is manual, small mistakes add up. Operational errors are among the issues the IRS and the Department of Labor find most often when they look at small business plans.

Payroll integration does not get much attention, but it is one of the more practical upgrades a plan sponsor can make.

What payroll integration is

Payroll integration is a data connection between your payroll system and your plan's recordkeeper. Contributions and employee information flow automatically instead of being typed in or uploaded by hand.

Not all integrations are the same. They generally fall into three levels:

Full two-way integration. Payroll sends contributions and employee data to the recordkeeper, and the recordkeeper sends back deferral changes, enrollment elections, and loan repayment amounts. When an employee changes their contribution rate on the recordkeeper's website, the change flows to payroll without anyone retyping it.

One-way integration. Payroll sends data to the recordkeeper automatically, but changes made at the recordkeeper still have to be entered in payroll by hand.

File upload. Someone exports a file from payroll and uploads it to the recordkeeper each pay period.

Errors integration helps prevent

Manual processes leave room for a familiar set of problems:

• Contributions deposited late because the person responsible was out or busy
• Deferral amounts that do not match an employee's latest election
• Eligible employees who are never enrolled, a particular risk in plans with automatic enrollment
• Bonuses or overtime handled inconsistently with the plan's definition of compensation
• Loan repayments that are missed, duplicated, or keep going after a loan is paid off
• Terminated employees who are not reported, which affects eligibility, vesting, and distributions

The IRS lists failing to follow the plan's definition of compensation and failing to enroll eligible employees among the common mistakes in its 401(k) Plan Fix-It Guide.

Deposit timing rules

Late deposits deserve their own mention because they come up so often.

Under Department of Labor rules, participant contributions must be deposited as soon as they can reasonably be separated from the employer's general assets, and no later than the 15th business day of the following month. That outer deadline is not a safe harbor. If you can deposit sooner, you are expected to.

For plans with fewer than 100 participants, the DOL offers a safe harbor: deposits made within seven business days of the date the money was withheld from pay are considered timely.

Late deposits are treated as prohibited transactions. They must be corrected, including lost earnings for participants, and reported on the plan's Form 5500. An excise tax may also apply. The DOL's Voluntary Fiduciary Correction Program offers a path to fix them, but the easier route is not letting them happen.

What integration does not fix

Integration moves data faster. It does not make the data right.

If a pay code is set up incorrectly in payroll, for example a bonus code marked as excluded when your plan document says bonuses count, the integration will faithfully send the wrong number to the recordkeeper every pay period. When you set up an integration, review:

• Which pay codes count as plan compensation, compared with the plan document
• How hours are tracked if eligibility depends on hours worked
• How hire dates, rehire dates, and termination dates are recorded
• How loan repayments are set up and stopped

Revisit that mapping whenever you change payroll providers, add new pay types, or amend the plan.

Questions to ask your providers

• Does our payroll provider integrate directly with our recordkeeper, and at what level?
• Who reviews the data each pay period before or after it is sent?
• How do participant deferral changes reach payroll?
• How do we confirm and track the timing of each deposit?
• When were our pay codes last compared with the plan document's definition of compensation?
• Is there a setup fee or ongoing cost for the integration?

If you are changing providers

Integration is worth weighing when you evaluate a new recordkeeper or payroll company. Some combinations connect smoothly and others do not connect at all. A lower fee from a provider that forces you into manual uploads can end up costing more in staff time and corrections.

Want a second look at how your plan's payroll process is working? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm meets with business owners to review plan operations and providers. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.

Frequently asked questions

Does payroll integration cost extra?

Sometimes. Some providers charge a setup fee or a per-payroll fee, while others include integration in their standard pricing. Ask both your payroll provider and your recordkeeper.

Is a late deposit a big deal if it is only a few days late?

It is a prohibited transaction that must be corrected, though the lost earnings owed are often small. Correcting it promptly and fixing the underlying process keeps it from becoming a pattern.

Who is responsible if the integration sends the wrong data?

The plan sponsor remains responsible for operating the plan correctly. Integration reduces errors, but regular review of payroll and recordkeeper reports is still important.

This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.