IRS Sounds Alarm on Major 401(k) Mistakes You Must Avoid

According to new data from Fidelity's Q1 2026 retirement analysis, the current savings rate for 401(k)s is now 14.4%. This is higher than in previous years and is likely due to the widespread adoption of automatic enrollment.

While a bigger participation in 401(k) plans is positive news, many employers, HR professionals, and workers still make financial mistakes with 401(k)s. The IRS lists these mistakes in its 401(k) Fix It Guide. Here are some of the most common ones, so you can learn to avoid them. The good news for employers and employees is that most are preventable.

Small business owners, HR administrators, and employees can make mistakes

Whether you're a business owner, an HR administrator for a small or large company, self-employed, or an employee, you can make a mistake with your 401(k).

Business owners hold most of the responsibility, as they are required by law to comply with IRS rules and manage plan documents. Employees make mistakes, too, though, especially if they change jobs or take out a 401(k) loan. All parties can do their part to minimize errors, as they can be costly for both the business and the employee.

Common 401(k) loan administration mistakes

Taking out a 401(k) loan may seem simple, but employees have to follow specific steps outlined in IRC Section 72(p), which limits loan amount caps, repayment requirements, and the length of the loan term. 

If an employee doesn't make repayments according to this policy, their loan could count towards income tax, and depending on their age, they may get a 10% early withdrawal penalty too. That's why it's a good idea for employees to understand how repayment works and what happens if they get laid off or switch jobs before taking out a 401(k) loan.

Top-heavy plan failures

When a 401(k) plan is "top heavy," it means that a majority of the 401(k) money in a business's plan goes towards business founders or executives. When that happens, the plan has to follow certain guidelines, like making sure lower-ranking employees have specific minimum contributions. 

If small businesses don't follow these guidelines closely, their plan could be disqualified, which can lead to tax issues.

When eligible employees are excluded from plans

Another common mistake is when employers inadvertently exclude eligible employees from 401(k) plans. Sometimes this happens because of misclassification, confusion about part-time worker rules, or other factors. However, this mistake can be costly for employees because not only do they miss the opportunity to contribute, but they may also miss out on employer matching contributions.

The IRS guidelines require employers to regularly review eligibility rules and correct any errors affecting employees.

Making excess contributions above the maximum

In 2026, the 401(k) maximum contribution limit is $24,500. Those who are age 50 and up can make an extra $8,000 catch-up contribution for a total of $32,500. Workers between 60 and 63 get the biggest catch-up opportunity, with the ability to contribute an extra $11,250.

However, if you accidentally contribute more than the maximum, which can happen if you switch jobs or accidentally make a double payment, you'll need to correct the error with the IRS, or it could result in double taxation.

Missed required Form 5500 filings

The IRS says that employers are responsible for filing Form 5500, which is an annual report that contains information about the company's 401(k) plan. Even if businesses use accountants for their paperwork administration, sometimes people forget to submit this form. 

The IRS recommends that businesses understand all their form requirements.

Mismanaging hardship distributions

There are new 401(k) policies about hardship distributions, namely that employees can withdraw $1,000 without penalty from their 401(k) plans for a qualified hardship if their plan allows it.

However, sometimes 401(k) plan providers mismanage these distributions or allow them when the plan does not, which can create problems at tax time. The IRS recommends that if a company mishandles a hardship distribution, they need to ensure plan administrators understand hardship policies.

Always verify 401(k) policies

Typically, employers are responsible for ensuring they stay compliant with 401(k) rules. However, it's still a good idea for employees to verify their contributions and ensure their employers are managing their plan correctly. Being aware of 401(k) rules is especially important if employees switch jobs, make a hardship withdrawal, or take out a 401(k) loan.

Bottom line

A 401(k) is one of the best ways to work toward your retirement goals. However, 401(k)s also come with a hefty set of rules and regulations. Business owners, HR employees, and workers themselves should take the time to familiarize themselves with 401(k) requirements to avoid potential penalties.