What Happens if Employee 401K Contributions Are Missed or Late?

Missed Contribution Example: An employee set their 401(k) contribution percentage to 10%, but the business never updated the contribution percentage in their payroll system.

The Example Situation: An employee is auto-enrolled in the company's 401(k) plan at 3%. Then the employee accesses their online 401(k) management portal to change their contribution to 10%. The company does not make this change, and the issue is not recognized until 12 months later. 

What Happened: The employee made a valid deferral election using their online 401(k) management portal. Under ERISA, that election is legally binding. The employer's failure to implement it, regardless of whether it was a software sync issue, a manual update that got missed, or a communication breakdown, means the employee was under-withheld every pay period from the moment the change was requested.

The Employer's Obligations: The IRS addresses this directly under the EPCRS (Employee Plans Compliance Resolution System). It's classified as a missed deferral opportunity, and the correction is specific:

• The employer must calculate the missed deferrals for every pay period affected. This is calculated as the difference between what should have been withheld (10%) and what was withheld (3%).

• The employer cannot go back and take the missed 7% from future paychecks retroactively. The employee already received that money as take-home pay, and clawing it back is not permitted.

• Instead, the employer must make a Qualified Nonelective Contribution (QNEC) into the employee's 401(k) equal to 50% of the missed deferral amount, plus lost earnings on that amount. (Some plans require 100%, the percentage depends on the plan document and when it's corrected.)

• The QNEC is funded entirely by the employer, not the employee.

The Employee Lost Earnings: On top of the QNEC, the employer owes lost investment earnings from the date each contribution should have been deposited to the date it actually is. This is calculated using the IRS or DOL calculator and can be meaningful if the error ran for multiple pay periods.

The Tax Angle: The missed deferrals were paid out as regular wages, so the employee already paid income tax on them. The QNEC the employer puts in is pre-tax and grows tax-deferred, but it doesn't fully replicate what the employee would have had; they lost the pre-tax benefit on the missed portion.

What Should You Do If You Find a Missed or Late 401(k) Contribution?

If you discover a possible issue, act quickly. Do not ignore the issue and hope it balances out later. Retirement plan errors usually become easier to correct when they are found early. Start by identifying the affected payroll dates, employees, contribution amounts, and the date the deposits should have been made. Then confirm whether the money was withheld from payroll, whether it was deposited into the plan, and when the deposit occurred.

From there, work with your 401(k) provider or plan administrator to determine the correction. You may need to calculate lost earnings, make corrective deposits, update employee accounts, and document the fix.

The Correction Process: VFCP and Self-Correction

The good news is that the DOL and IRS both offer pathways for employers to correct these violations voluntarily. Using them is almost always better than waiting to be found during an audit.

The Voluntary Fiduciary Correction Program (VFCP)

The DOL’s VFCP allows employers to self-report late contributions, calculate and restore lost earnings using the DOL’s online calculator, and receive a no-action letter from the DOL in return. This closes the violation formally and protects the employer from further enforcement action on that specific issue. There are filing requirements and documentation standards to follow, but for employers who made a genuine mistake and want to fix it, the VFCP is the right path.

IRS Self-Correction Program (SCP)

For certain operational failures, the IRS allows plan sponsors to correct errors under the Employee Plans Compliance Resolution System (EPCRS) without filing with the IRS, as long as the failure was not egregious and is corrected within specific timeframes. This can cover missed or incorrect contributions, enrollment errors, and certain match miscalculations. An ERISA attorney or retirement plan advisor should be involved in evaluating which correction method applies.

Important: Employers who discover a contribution error should document the issue, calculate lost earnings as soon as possible, and consult a benefits advisor before doing anything else. Acting quickly and intentionally is far better than hoping the issue goes unnoticed.

How long does the employee have to recognize the error & how long does the employer have to correct the issue?

IRS guidance says an employer cannot avoid responsibility for corrective contributions by making employees responsible for checking pay records to ensure their deferral election was implemented. In other words, employees should review paystubs and 401(k) accounts, but the employer still has the duty to operate the plan correctly. 

For the Employee

There's no strict federal deadline for an employee to notice or report the error. ERISA's general statute of limitations for breach of fiduciary duty claims is:

• 6 years from the date of the breach, OR

• 3 years from the date the employee had actual knowledge of the breach, whichever is earlier

So an employee who notices their balance looks off three years after the fact can still pursue a claim. And since most employees can see their account balance and contribution history in an online portal anytime, "actual knowledge" can be argued to start the moment the records were visible, but that's often disputed.

For the Employer

This is where it gets more pressing. Under the IRS correction framework (EPCRS):

Same plan year: The employer can self-correct under the Self-Correction Program (SCP) with minimal cost. It is just the QNEC (50% of missed deferrals) plus lost earnings. No IRS filing required.

Within 3 years of the plan year end: Still eligible for SCP, but the correction requirements are stricter and documentation needs to be thorough.

Beyond 3 years: The employer generally must file under the Voluntary Correction Program (VCP), which involves submitting the error to the IRS, paying a compliance fee, and waiting for IRS approval before correcting. More expensive and more exposed.

If the IRS finds it first: The employer loses access to VCP entirely and is subject to Audit CAP, a negotiated sanction that is almost always significantly more costly than voluntary correction would have been.

The practical takeaway: Every pay period the error goes uncorrected adds more missed deferrals, more lost earnings, and more complexity to the correction calculation. There's no grace period where it stops accumulating. The employer's cost grows with time, while the employee's ability to make a claim stays open for years.

How Horizon Payroll Can Help

Managing 401(k) contributions accurately requires more than just running payroll on time. It requires a connected workflow where plan deductions are tracked, transmitted, and reconciled without relying on manual steps that can break down.

At Horizon Payroll, we help employers set up payroll processes that reduce the risk of missed or late contributions. Our 401(k) partner, Human Interest, works with businesses of all sizes, from small teams with straightforward retirement plans to larger organizations managing more complex deduction structures. Together, our goal is to make sure that the money withheld from your employees’ paychecks gets where it is supposed to go, on time, every time.

If your current process involves manual data entry between your payroll system and your retirement plan provider, or if you’ve experienced contribution errors in the past and want a more reliable setup, we’d be glad to take a look at how your workflow is structured and help you tighten it up.

Ready to eliminate the risk of late 401(k) deposits? Contact Horizon Payroll at 1 (888) 434-8244 or send us a message to schedule a payroll and 401(k) review with our team.

This post is for general informational purposes and does not constitute tax or legal advice. Consult with a qualified tax advisor or attorney before making decisions about your retirement plan.