If you are the Plan Sponsor of a 401(k) Plan, you may have heard that you at some point the Plan will need an audit. If this comes as a surprise to you, this blog post may help.
Most benefit plans are subject to a federal piece of legislation titled the Employee Retirement Income Security Act of 1974 – usually referred to as ERISA. This legislation was passed by Congress almost 50 years ago as companies moved away from defined benefit plans to defined contribution plans (a 401(k) plan is a type of defined contribution plan). Congress was concerned that as employee/participant money was withheld from each paycheck and then deposited into a company sponsored fund, there would be opportunity for mismanagement or fraud related to the plans. The overall objective of ERISA is to protect the participant money in the Plan accounts.
One of the provisions within ERISA, provides for required plan audits by an independent CPA. These audits are only required once the number of eligible participants for the Plan reaches a count of 100 or more. This sounds very straightforward but it can be more complicated. Let’s explore some areas you need to consider as you are reviewing if you will need an audit.
- What is the definition of eligible participants?
Per the current definition, this should include active employees of your company that are making contributions into the Plan. However, it should also include terminated employees that have an active balance in the Plan. It should also include employees that are receiving compensation during the year and were eligible to participate but have chosen not to. All three types must be included to determine the total number of eligible participants. Many sponsors are not aware of the need to include both terminated employees that have balances and active employees that are not participating in the count.
- How can I determine the number of eligible participants?
This can be a bit tricky. One tool to utilize is your payroll system. You should be able to run a report or view a payroll report already created that will show the employees contributing to the Plan. A report from your 401(k) service provider should be able to show you the terminated employees that still have active balances. You will usually need to review a report out of your payroll or HR systems to determine the number of active employees that are eligible but not participating.
- When should I measure the count of eligible employees?
For determining if an audit is required, you should count the eligible employees as of the first day of the Plan year. This is usually January 1st but if your Plan is not on a calendar year basis it will be a different date. It does not matter that during the year, you may have terminated the Plan or had a significant decline in the count. The only measurement that matters for this purpose is the first day of the Plan year.
- What is the 80-120 Rule?
There is another wrinkle in determining if you will need a Plan audit. This is provision called the 80-120 Rule that plans may be able to take advantage of. The important part of this provision is that if your eligible count as described above goes over 100 but is less than 120 and you filed a Short Form 5500 in the prior year, you can continue to file a short form (which also means no audit is required) for the current year. Once your count goes above 120, this no longer applies. You can continue to use this provision for more than one year until your count exceeds 120. As an example, for the 2020 plan year, the plan had a count of eligible participants of 97 as of January 1, 2020. They did not require an audit and a Short Form 5500 was filed because the Plan qualified as a small plan. As of January 1, 2021, the Plan now has an eligible count of 106 participants. They are over the 100 count limit on January 1, however, because of the 80-120 rule, they would not be required to have an audit. Their count remained below 120 and they filed as a small plan filer in the previous year.
If you have completed the above calculations and you believe your Plan requires an audit, we first recommend that you review your results with your third-party administrator or recordkeeper to ensure you have completed the calculation correctly. This is especially important if the counts are very close to the threshold (i.e., your count is 99, 100, 119, 121, etc.). It is important that a correct calculation is made early so if an audit is needed it can start early to ensure completion before the deadline.
Once you have determined that you need an audit, begin the search for the audit firm right away. First audits take longer to complete than recurring ones and audit firm schedules will get booked up. Don’t delay in this next step.
At Summit CPA we specialize in retirement plan audits. If you would like to discuss our audit process in more detail or need an audit contact our office at (866) 497-9761 to schedule an appointment. We can help you navigate the world of the 401(k) audit as proficiently as possible. We also offer off-site assistance and flat-fee pricing so there are no surprises when the job is complete.