Executive summary

Payroll is central to every organization, not only for compensating employees, but also as the foundation for retirement and benefit programs. This function is essential for organizations of all sizes and industries and becomes even more significant for those sponsoring retirement plans (such as 401(k), 403(b), or defined benefit plans) or other benefits (including health, welfare, and flexible spending accounts). Payroll data is the bedrock for benefit contributions and premiums, eligibility determination, and other processes that require regulatory compliance.

The payroll process and the various parts that make it work are generally taken for granted. The process tends to only receive attention when something stops working, and errors and issues that must be addressed arise. These errors generate operational failures, have the potential of increasing regulatory risks, and can diminish the trust relationship between employee and employer. Maintaining a reliable process can reduce operational errors, bypass unnecessary fiduciary risk, and support talent retention and attraction.

This paper explores the relationship between payroll integrity and benefit outcomes. It also outlines best practices for employers that seek to modernize and enhance payroll processes, leverage payroll data for broader strategic value, and reduce risk.

Payroll as the primary data source for retirement programs

Contribution accuracy

Defined contribution plans require payroll data—wages, hours, bonuses, commissions—to calculate elective deferrals, profit-sharing, and employer matching contributions. Errors in compensation definitions or missed pay categories (e.g., overtime, bonus pay, special awards) can lead to incorrect contributions for employees. For example, consider an employee whose earnings definition includes overtime as stated in the plan document with an employer match contribution. If payroll inadvertently excludes overtime compensation as a deduction code in the programming, the employee receives a smaller employer match than they are entitled to. Such errors force corrective contributions, potential lost earning calculations, and increase administrative costs. Interestingly enough, failure to follow the plan’s definition of compensation ranks No. 2 in the top ten failures the Internal Revenue Service (IRS) finds in their Voluntary Correction Program,¹ and is also a common error found in pension calculations according to the U.S. Department of Labor (DOL).²

Annual nondiscrimination testing

401(k) plans must pass different nondiscrimination tests, such as the actual deferral percentage (ADP) and actual contribution percentage (ACP) tests. In order for these required tests to produce accurate results, the data provided through payroll is critical. Items such as compensation, employee deferrals, employer match are all crucial components of the computations of these tests. Incomplete or incorrect data jeopardizes test results and could force corrective refunds or additional employer contributions with associated tax implications. This is just one more activity that can increase administrative and overall costs.

Vesting and service tracking

Many plans tie eligibility, vesting, or both to hours worked by an employee. Payroll is generally the sole repository of hire dates, termination dates, rehire status, and hours. Inaccurate service records can result in wrongful forfeiture of employer contributions or delayed eligibility. According to Smith + Howard’s accounting and audit division, failure to enroll employees based on a plan’s eligibility requirements ranks No. 4 in the top errors that may occur. This is immediately followed by failing to administer auto-enroll correctly.³ Correcting such errors can be labor-intensive and may require costly adjustments of plan records.

Payroll’s role in health and welfare benefits

Premium deductions and cost-sharing

Health insurance, dental, vision, and other benefits typically require employee premium contributions via payroll deduction. Incorrect deductions can lead to potential funding shortfalls or overcharges. In general, this may impact the employer’s internal budget as they are obligated to pay claims or premiums to the carriers directly.

Flexible spending accounts and health savings accounts

Flexible spending accounts (FSAs) and health savings accounts (HSAs) are tax-advantaged accounts that have statutory contribution limits. In this function, payroll, in conjunction with employee benefit platforms, must cap contributions, apply catch-up eligibility rules, and track midyear election changes under qualifying life events. Failure to enforce limits risks disqualifying the entire plan and compounding tax liabilities for all participants.⁴

Leave and disability benefits

Accrual and payouts for benefits such as disability programs, sick time, paid parental leave, and available vacation time generally stem from information held in payroll systems. Incorrect data, such as attendance, can lead to erroneous balances being communicated to an employee. Due to the sensitivity for most employees around these benefits, these errors can lead to a strain in employee relations.

Regulatory environment

ERISA, DOL, and IRS oversight

In the United States, an employer can generally expect to be audited by two different departments, the Department of Labor (DOL) and the Internal Revenue Service (IRS). While the two entities focus on different aspects as part of their audit, some of those aspects overlap. One key and integral part of audits and investigations is the review of payroll records. Errors discovered during a review may lead to potential penalties and plan disqualification.⁵

Data privacy laws

Data privacy laws are generally in an upward trend globally. These laws have requirements on how employee data is collected, used, shared, and stored. Payroll teams and payroll processes are now subject to stricter rules, stronger transparency, and stronger oversight of the various service providers that have access to employee data. In the United States, timelines to report a breach vary from state and sometimes carry specific notification requirements.⁶

Indirect impact on employee experience

Employee trust and engagement

Errors in payroll may lead to employees losing confidence in their employer, and potentially into increased turnover rates. Some studies suggest that more than half of employees would consider leaving an employer if payroll mistakes are not properly addressed and managed.⁷ Accurate and timely payroll processes help maintain or increase employee satisfaction while reducing the employer’s risk of unwanted audits, fines, and other legal complications.

Financial wellness initiatives

The success of employee financial wellness programs are highly correlated to accurate payroll data. Programs such as emergency savings accounts and student loan repayment assistance are initiatives that require a seamless and efficient integration with payroll, and one that is free of error.

Best practices for building a high-integrity payroll process

Governance committee

• Establish a payroll governance committee that includes personnel from Human Resources, finance, information technology, and legal/compliance.
• Maintain a payroll process manual that documents data sources, workflows, and control points.
• Appoint a data steward with authority to oversee and regulate code changes or overrides.

Data architecture

• Implement consistent pay codes and compensation definitions for base pay, bonuses, overtime, and fringe benefits.
• Leverage unique employee identifiers to prevent duplicate records in service provider files.
• Retain point-in-time snapshots for reference and audit trails.

Service provider integration

• Use automated secure file transfer protocol or application programming interface-based feeds to send payroll data to recordkeepers, insurers/carriers, and brokers.
• Test new data fields in advance of launch and confirm file mappings at least annually. Errors can occur when new data fields are added mid-year and systems are not updated accordingly.
• Discuss with service providers validation reports that can be created to alert of any discrepancies, within a reasonable amount of time after each payroll cycle. Errors tend to occur when an employer issues a manual or off cycle payment. These errors do not generally occur on routine benefit deductions. Vendor validation reports can help catch errors associated with these exclusions.

Timeliness and reconciliation

• Follow the DOL’s earliest-date-that-is-administratively-feasible standard for remitting deferrals; for small plans ( fewer than 100 participants), this is typically within seven business days.
• Implement daily or per-pay-cycle reconciliations: contributions reported vs. cash remitted, head count vs. benefits enrollment, tax withholding balancing.
• Document exception handling procedures.
• Review trends with the goal of driving continuous improvement.

Controls and automation

• Consider dual approvals for off-cycle checks or manual adjustments.
• Implement validation rules (e.g., reject any 401(k) deferral that exceeds statutory limits).
• Conduct internal audits of payroll systems, track and address any issues that require remediation, and record action steps and closure.

Testing and auditing

• Perform interim tests of nondiscrimination analyses using midyear data to identify material or substantial changes in the results from prior years.
• Engage an external independent actuarial consultant if a defined benefit applies or an external consultant to conduct a mock audit mirroring DOL or IRS frameworks.
• Maintain evidence and documentation: calculation logs, screenshots, records, and signed approvals to defend against claims or litigation.

Employee access and transparency

• Train and communicate to employees on where information can be obtained about benefit deductions, benefit contributions, and current balance.
• For employees that are on track to reach annual limits, send out proactive communications to encourage action, if applicable.
• Use easy to understand language when communicating with employees (e.g., “An employer contribution of [$X] was made to your retirement account this pay period”).

Technology trends affecting payroll and benefits integration

Real-time pay and on-demand wages

Fintech platforms are changing when and how often an employee gets paid. Through these tools, employees are provided with the option to access their salary before their actual payday. While these on-demand options can be an enhanced benefit for employees, employers still must ensure contributions, deductions, and tax withholding all process accurately.

Secure data exchange standards

Emerging standards such as Financial Data Exchange and open finance application program interfaces will streamline connectivity between payroll, recordkeepers, and other financial apps, but will come with a new set of security considerations.⁸

Artificial intelligence for anomaly detection

Artificial intelligence can be leveraged to scan payroll data for irregularities such as sudden spikes in deferred compensation, unusual changes in deduction patterns, or negative net pay. Some early adopters see a significant reduction in payroll-related corrections.

Legislative changes

Legislative activity has increased dramatically in recent years in the United States. New laws expanding coverage, such as SECURE 2.0, and state auto-IRA mandates, will undoubtedly increase the compliance burden on payroll and simultaneously increase the risk. Similar shifts are occurring globally, such as the pension auto-enrolment expansion in the UK, all of which require a payroll process that is agile and flexible.

Return on investment of payroll modernization

Organizations considering investment in cloud-based payroll platforms accompanied with robust governance can expect:

• To increase accuracy and reduce errors.
• To experience time savings through automation.
• To improve their regulatory compliance.
• Enhancements in data security, audit trails.
• Custom reports and analytics.
• Reduced inquiries from employees from the use of self-service options.

The decision to modernize payroll should include:

• Initial and ongoing costs.
• Maintenance, migration, and adoption challenges.
• Security and privacy issues.

Alternatives to the existing payroll vendor should be evaluated and retained for reference in case a change becomes necessary in the future. Being heavily dependent on a specific payroll vendor may not be ideal.

Next steps: Implementation road map

The roadmap below lists some considerations that may help complement your existing payroll process.

Step 1: Assess and identify

• Map and document current payroll processes and data flows.
• Review and benchmark error rates and compliance exposure.
• Identify pain points by interviewing stakeholders.

Step 2: Define scope, priorities, and timeline

• Define the target-state design and governance model.
• Focus on gaps based on risk, cost, and economic value.
• Create a phased rollout plan that includes some easily achievable goals (e.g., automated deferral limit checks).

Step 3: Build and integrate

• Configure system enhancements, with particular attention to new or revised validation rules.
• Develop secure integrations with service providers; perform end-to-end testing before final implementation.
• Hold training sessions on core functionalities, new procedures, and escalation steps.

Step 4: Operate and optimize

• Monitor key performance indicators including error rate, resolution time, and compliance metrics.
• Conduct quarterly mini audits of benefit calculations.
• Make and document adjustments based on findings with the goal of continuous improvement.

While payroll’s primary function is paying employees, its reach also impacts retirement and other benefit offerings. Operational errors, fiduciary exposure, and regulatory scrutiny can all be reduced through an efficient and robust payroll process. A process that is effective and error-free can help maintain or increase employee satisfaction.

Milliman’s experience across industries indicates that organizations investing in payroll data integrity, automation, and governance may avoid costly penalties and minimize risk; added benefits include improved retirement readiness, higher employee engagement, and better alignment between benefits and overall business objectives.

As employers continue to navigate an evolving regulatory environment that injects new complexities into benefit administration, in conjunction with high employee expectations, having a payroll process that is efficient and error-free can become an effective competitive advantage.

¹ Internal Revenue Service. (n.d.). Top ten failures found in Voluntary Correction Program. Retrieved December 23, 2025, from https://www.irs.gov/retirement-plans/top-ten-failures-found-in-voluntary-correction-program.

² U.S. Department of Labor. (n.d.). 10 common causes of errors in pension calculation. Retrieved December 23, 2025, from https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/publications/10-common-causes-of-errors-in-pension-calculation.

³ Perez, C. (April 10, 2024). Top 10 operational failures with 401(k) and 403(b) plans. Smith + Howard. Retrieved December 23, 2025, from https://www.smith-howard.com/top-10-operational-failures-with-401k-and-403-b-plans/.

⁴ First National Bank. (May 13, 2024). What happens if you contribute too much to your health savings account? Retrieved December 23, 2025, from https://www.fnb247.com/education-center/news/health-savings-accounts/what-happens-if-you-contribute-too-much-to-your-health-savings-account/#:~:text=Another%20reason%20for%20excess%20contributions,distribution%20from%20your%20HSA%20provider.

⁵ Langan, A. (May 3, 2024) How To Fix Your 401(k) Plan – Five Most Common IRS Red Flags for 401(k) Plans Retrieved January 11, 2026 from https://langanfinancialgroup.com/fix-401k-five-common-irs-red-flags/#:~:text=or%20delayed%20distributions.-,What%20are%20the%20Common%20401(K)%20Audit%20Penalties?,no%20maximum%20from%20the%20DOL.

⁶ Gerlicher, A. (2025). 2025 Security Breach Notification Chart. Retrieved January 11, 2026, from https://perkinscoie.com/insights/publication/security-breach-notification-chart.

⁷ Warner, C. (September 17, 2025). New study: Payroll mistakes create turnover risk for 50% of workers. HRMorning. Retrieved December 23, 2025, from https://www.hrmorning.com/news/payroll-mistakes-hr-finance/#:~:text=The%20survey%20shows%20that%20nearly,reporting%20to%20maintain%20smooth%20operations.

⁸ SecureAuth. (n.d.). Financial Data Exchange. Retrieved December 23, 2025, from https://docs.secureauth.com/ciam/en/financial-data-exchange--fdx-.html#:~:text=Financial%20Data%20Exchange%20(FDX)%20aims%20to%20unify,and%20business%20access%20to%20their%20financial%20data.