How to Audit Employee Deferral Elections Against Payroll Deductions

A 401(k) deferral election audit compares what each eligible employee elected with what payroll actually withheld, then resolves every difference before it becomes a plan-operation failure.

A clean payroll feed can still hide a bad election file. A percentage may be keyed incorrectly, a change may miss an effective date, or a new employee may never reach the election workflow. A repeatable comparison makes those breaks visible while the payroll records and participant communications are still easy to reconstruct.

Define the operating question

An election is the employee instruction that tells the employer whether and how much to defer from compensation. The audit is not simply a total-dollar reconciliation. It is a participant-by-participant comparison of eligibility, election history, compensation used by payroll, withholding, deposit records, and the plan document. The IRS fix-it guide directs sponsors to operate the plan according to its terms and to identify and correct operational mistakes rather than leaving them embedded in routine processing.[1]

Before reviewing individual transactions, write the question in a way that can be tested: which people, pay periods, contribution source, and plan provisions are in scope? Use source-system extracts with an “as of” date and preserve the version of the plan materials used. That discipline separates a defensible finding from a report that merely looks complete.

Compare records before drawing a conclusion

The key distinction is between a data variance and an operational variance. A data variance may be a report timing issue that disappears after a file refresh. An operational variance remains after the records are aligned: payroll withheld a rate different from the valid election, or an eligible person did not receive the opportunity to elect. Treat the latter as a documented exception requiring counsel or a qualified administrator to assess correction.

Use a variance log that records the participant or payroll population, source records, initial explanation, owner, due date, and disposition. Do not silently overwrite a difference to make totals agree. A documented “not an error” conclusion is valuable because it shows why the reviewer rejected the exception.

Make the comparison reproducible. Save the original extract names, filters, report dates, and calculation version, then have another reviewer rerun a small sample from the same evidence. This is especially important when a payroll code, job classification, or plan amendment changes during the review period. A control is more reliable when it can explain both a matched item and an exception. Where information is incomplete, label the item as pending rather than guessing an effective date or contribution source. The resulting file gives the sponsor a practical audit trail and a clearer handoff if outside counsel or a plan specialist needs to evaluate a potential correction.

Implement a controlled response

Once a variance is confirmed, contain the issue first. Stop the faulty configuration or manual process, preserve the records, and identify whether additional payrolls or populations use the same rule. Then use a consistent case file: facts, governing terms, analysis, professional advice, corrective amounts if applicable, approvals, funding evidence, participant communications, and prevention steps. The right sequence depends on the plan and facts, so administrators should involve ERISA counsel, a qualified TPA, or other appropriate advisers before selecting a correction method.

1. Freeze a dated population file showing hire date, eligibility date, status, compensation, and payroll group.
2. Pull the election history, including effective dates, opt-outs, changes, and any automatic-enrollment default.
3. Map each pay period to the applicable election and calculate the expected withholding using the compensation definition in the plan.
4. Compare expected withholding, actual withholding, and trust deposit by employee; sort exceptions by dollars and by repeated pattern.
5. Research each exception with payroll, HR, and the recordkeeper; retain the evidence, decision, correction, and preventive control.

Assign one owner for the case, but do not make that person the only reviewer. Payroll can validate source data, HR can validate employment events, and the recordkeeper can validate posting. The plan administrator should retain the final decision trail. This division makes it easier to distinguish a data correction from a plan-operation correction and reduces the risk that a fix in one system is never reflected in another.

Review the control, not only the case

Reconcile after each payroll and perform a broader quarterly review of hires, rehires, leaves, and election changes. A monthly exception report should show open owner, age of item, money impact, and whether a deposit or participant communication is pending. Review the process whenever payroll codes, vendors, or eligibility rules change.

Practical review table

Close the review by asking whether the control would detect the same failure next month. If the answer depends on a person remembering a special step, convert that step into an owned report, a documented approval, or a system validation. Retain both the original exception and the proof of the changed process. Periodic samples should confirm that the control is operating in practice, not merely written into a procedure.

Editorial disclaimer: This article is general educational information, not legal, tax, investment, actuarial, or compliance advice. Plan documents, facts, and current guidance can change the result; consult qualified advisers before acting.

Educational information only; not tax, legal, actuarial, investment, or compliance advice. Plan documents, current law, and qualified professional review control any decision.

References

• [1] https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide