This article explains the process of how funds flow from an employee’s paycheck into their 401(k) plan account and addresses common questions.
How Does the Payroll Deduction Process Work?
- Employee Earns Pay - Employees are paid for their work through the company’s payroll.
- Employee Opts to Save - The employee, after satisfying the plan’s eligibility rules, decides to participate in the 401(k) plan and decides to contribute a percentage or dollar amount from their paycheck to their retirement plan.
- Funds Withheld From Paycheck - The elected amount (e.g., $50) is withheld from the employee’s paycheck and remains in the company account temporarily.
- Funds Deposited Into the 401(k) Plan - The withheld contributions are transferred to the employee’s 401(k) account, along with any applicable employer match.
Why Can’t Employees Contribute Directly?
Some employers wonder why employees can’t contribute directly from their personal bank accounts. Because a 401(k) plan is offered by an employer and is considered a tax-qualified plan, the IRS does not allow participants to contribute to their plan directly and all contributions must be made through the employer’s payroll system. That centralized mechanism for contributions enables recordkeepers like Vestwell to more accurately track employer-matching contributions, loan repayments, and compliance with IRS contribution limits.
In short, in order for your company and your plan participants to get all of the tax benefits available from a 401(k) plan, the process requires all contributions to be made by the employer’s payroll system to enable better and more streamlined compliance with federal regulations.
The Importance of Timely Deposits
As we explain in our services agreement, and in order to comply with federal law, employers must make sure all contributions that their participants want to make to their retirement plan are deposited into their 401(k) accounts promptly. Delayed deposits can result in penalties by the IRS and Department of Labor, an obligation to pay lost investment earnings to any affected participant, correction fees that are in accordance with our plan service agreement, and other compliance issues for the plan that can be costly to correct. Contributions should be deposited within seven business days after the funds are withheld from paychecks. For additional details, please see:
Avoiding Common Missteps
- Don’t Block ACH Requests - Blocking ACH requests for plan contributions can delay deposits and result in compliance issues. As we explain in our services agreement, clients must inform their bank to accept transactions from Vestwell. Note: Please confirm you whitelist Matrix/Vestwell (ACH Authorized Code: 2133439945) to allow for ACH edits. Find additional information here.
- Understand Your Responsibilities - As an employer sponsoring a 401(k) plan, it’s your client’s responsibility to confirm contributions (employee and employer) are processed accurately and on time. We explain all of these responsibilities in our services agreement and in tutorials and articles in our Help Center.
By following these processes and understanding their importance, advisors can help maintain a smooth and compliant retirement plan for their clients. For further questions, please contact us at clientsuccess@vestwell.com.