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Common errors in 401K Audits [Part 2]

Published by Summit Marketing Team on Jun 8, 2020 6:00:00 AM

The 401(k) Audit CPA Success Show: Episode 8

Last month we talked about the most common findings in 401k audits. In this episode, Jamie Nau sits down with Kim Moore, the Summit CPA audit director, to continue the conversation.

Even if you don’t need an audit, this episode will help you to be aware of anything you need to know if you provide a 401k plan for your employees.

Jamie Nau: Welcome to today's podcast. This month, we are going to continue talking about what we talked about in last month's episode where we talked about some of the common findings that we find in 401(k) audits, mostly related to compensation and contributions. So today we're going to go through the rest of the findings that we find. Again, we're joined here by Kim Moore. Kim how are you doing?

Kim Moore: I'm doing really well, thanks, Jamie, glad to be here.

Jamie Nau: Again, I know it's a topic that people are always interested in because again, you hear the word audit, and oftentimes what people think are, how will I get in trouble?

Kim Moore: What did I do wrong? We get asked that all the time by folks when it's their first time audit. What did I mess up? We usually hear, did I pass or not?

Jamie Nau: Pass fail grade, right?

Kim Moore: Exactly.

Jamie Nau: Awesome. So why would you start off with the first ones you are thinking about.

Kim Moore: I thought I'd start at the very beginning. If a person was going to sign up for a 401(k) plan, the first thing that they have to go through is what's called eligibility. And we see some errors in this area. They're not as common as some of the things we talked about last time with the compensation contributions, but we do see errors here. Most plans specify an age and/or service requirement for an employee to enter the plan. There's also some other things they can exclude, things like collectively bargain employees, employees in a union, things like that. We don't tend to see errors on that side. But with the age and/or service requirement, we usually specifying they have to be 18, 19, 20, 21. Those are the most common, or maybe no age requirement. You can be at any age and enter and then sometimes there's a service requirement. So you need to work three months, six months, a year with the employer before, then you're eligible to enter the plan. So first thing off is make sure that you understand what those requirements are. Make sure that whatever your procedures are to determine eligibility, whether that's something done by the plan's sponsor, or by a service provider, because it can work either way, make sure that whoever's doing that understands the rules and they're following whatever the plan document says. If you get in and you look at the plan document, and it says something other than what you've been doing or what you meant, then you need to get that amended to make sure that your procedures follow what the plan document actually says. A couple of other areas that we tend to see errors, these get a little bit kind of tricky to explain, but if you have folks that are interns, or more commonly seasonal employees, maybe you bring people on to work around Christmas time as an example, or maybe in the summer you have more employees and then they go away and then they come back again next year, those folks don't necessarily get bumped out of eligibility for a 401(k) plan unless you specifically exclude them. Quite often we hear people say, oh, well, we don't even offer a plan to our seasonal folks, or we don't offer them to our part time employees. That's only allowable if you specifically state that in your plan document, which usually folks don't. So an area to be careful of if you have folks that are not in your main group of employee based.

Jamie Nau: So far you've listed off some eligibility requirements that I want to make sure we're good on. So it’s okay to make sure people are eligible based on experience, or time of service. It’s okay to make sure people are eligible based on age, and it's okay to make sure people are eligible based off of the type of employee. So you could call out contractors, or seasonal, or any other. Are eligibility requirements typical what you see, or are there any other that are the most common?

Kim Moore: Those are the most common things we see. The other thing we run into, this isn't a plan document problem necessarily, it's more of an administrative problem, is that if you're specifying the service requirement, so you're saying not like three months or six months, but you're saying more like a thousand hours you need to work and then you're eligible after that point in time, you have to be careful how you're defining the thousand hours. Is it a thousand hours in a year, or is it a thousand hours cumulative? Because just like those seasonal folks, somebody might work 200 hours this year. They come back next year and work 300 hours, eventually if they keep coming back they're going to hit that thousand hours. We recommend to folks, if you can at all avoid setting your plan up that way it's better for you, because it just creates an administrative nightmare tracking that. But we have had a couple of plans that do that, and that's how they wanted it. We just said if that's what you're set on, that's fine. You just need to make sure you're following exactly what you've said, because I know we talked about it last episode. It goes back to documentation again. If you're going to have something that complicated you have to make sure you have the documents ready to go and keep up with it.

 Jamie Nau: More power to you, right?

Kim Moore: Exactly. If that's how you want it, that's fine. The other thing I was going to mention, and this is on the eligibility side, again, it hits the documentation that you just mentioned, we recommend folks document offering the plan to people, because a lot of your employees may choose not to participate, which is fine. That's totally their choice. But it is important that you can show that you offered them the plan timely, and that they actually did decline so they don't come back later and say hey, six years ago I said I wanted to be in the plan. You never did the right thing and started withholding money, that can cause you a lot of headaches down the road and could be a regulatory nightmare. So we recommend you just have a form. Maybe they fill it out and they put zero, or they check a box saying no, I don't want to participate, or even just keep an email. If you're offering via email, just keep the email and say hey, they never responded when I offered it to them. Whatever works for you with that.

Jamie Nau: What about online? So I know a lot of these 401(k) plans are set up through websites. I know ours is. If I went in there and hit zero, is that okay documentation?

Kim Moore: That would be. Yeah, that would be sufficient. It might be worth asking your service provider, how can I go back and see that? Is there a report I can run, or I can maybe see it online? A lot of the good websites will have a little screen that you can either click on, or it will run a report saying this person was offered on this day, and then usually there's just nothing past it because a person never even logs in, which is sufficient. That shows that they were offered.

Jamie Nau: So things around eligibility. What other areas are there?

Kim Moore: Yeah, let's move on to the next topic. This is a pretty easy one, it's called fidelity bond. Every 401(k) plan is required to have what's called a fidelity bond. The easiest way we tell folks, if you're not sure if you have one, is to talk to your insurance provider or look in your insurance documents. Look for something called a ERISA Bond, Fidelity Bond, employee, dishonesty bond. We see that a lot. They're called different things, but it's a type of coverage that's required to have as an employer. It's covering the actions of the folks there at your company as they're dealing with the funds coming out of the payroll and then getting transferred over to the plan, that time in between, to make sure that if they do anything by mistake, or more importantly it's really there to cover someone at some type of malfeasance, fraudulent activity, you can use that coverage to help reimburse the losses. Hopefully you never need it. The coverage isn't really very expensive, but it is a risk requirement. I will say that this is a hot button issue. It is reported on the 5500, regardless whether you need an audit or not. It’s something easy for them to check. They'll send you a letter. Again, you can be in trouble with the regulator. Definitely worth looking into. You need to make sure you got a bond. It covers the whole year. It's the right type of bond. The Treasury Department has a list of approved providers. There's a whole bunch of them so you shouldn't have any trouble in making sure you get the right kind of bond. Then it has to cover 10 percent of the beginning plan assets, or there are maximum amounts. So usually five hundred thousand, a million dollar coverage. Again, I don't want to scare anybody with those dollar amounts. What you're going to pay in premium is usually a couple hundred dollars. It's not a lot of money. Definitely worth checking into cause it's not worth the headache for no more than it cost your company. 

Jamie Nau: It’s required if you're a ERISA plan. Its required if you have a fidelity bond. So the first thing to do is look to make sure you have one. That's step one. If you don't have one, as you said there's a list of providers so you can contact those. Then again, you want to make sure it covers the whole year. You want to make sure it's in the name of the plan and it covers 10 percent of assets. So that's kind of a summary. That's pretty important to look into right now. Double check that right now. It’s a pretty easy thing to do. 

Kim Moore: It is an easy thing to do. Check with your insurance provider. If you find out you don't have it, or you're not sure, call up your carrier or your insurance agent. They can easily tell you. The other thing you want to make sure is to check the amount, because as the plan assets grow, what would have been an okay amount a couple of years ago may need increased. Again, we're not talking big dollars. Again, call your insurance agent. Just say hey, you know, I need to increase. Some of the bonds now are kind of auto escalation. So you just pay one fee and it'll cover you up to the max depending on, you know, if you'd ever need it. So those are those are easy fixes.

Jamie Nau: It’s probably something you should have on your calendar and check once a year. Check the amount, check the dates and just make sure it's good to go. It’s a five minute process.

Kim Moore: Yeah it is. Next area we would like to mention is something called discrimination testing. I don't want to spend a whole lot of time on this because it can get pretty complicated. But every year, a 401(k) plan is required to do some testing to make sure that it adheres to IRS requirements. It's called discrimination testing, because one of the things its doing is making sure that the plan isn't discriminating against the lower paid employees. So they don't want a small business, which may have an owner or a couple of owners, to set up a plan primarily in place to benefit their tax position. The IRS wouldn't like that. Or for a large company that may do the same thing but to benefit the officers, the senior executives. So a lot of this testing, again I won’t get into all of the details, a lot of this testing is just to make sure that everyone is treated equally, and it actually favors what are called non highly compensated folks versus the highly compensated folks. So there's testing that has to be conducted. Your service provider will do that for you. You don't need to worry about how to do it. Just make sure you follow their instructions. If you have any questions as you're working through giving them the data to begin the work, make sure you ask them, because if you don't give them the right data, then the results can be incorrect and that can cause you regulatory headaches down the road. So just make sure you're following their instructions. If you have any questions, ask them. Usually those providers will run the tests and they'll give you back the results. A lot of times they'll point out things that looked a little odd to them as they were running the tests. So things like an active employee that has no compensation, a terminated employee that has compensation, an employee that has no birthdate or no higher date, the term but no hire date. things like that. So you want to take a look at those. It’s usually a report or an e-mail that they might send back, because maybe that stuff was incorrect when you submitted the data, maybe it doesn't matter, but maybe it does. So take a look at those again. Have any questions, get back to your service provider. Make sure that the test is as correct as you can make it. Then at the end of all of that, they're going to either tell you that you passed all the tests and everything's good. If that's the case, I'd suggest you keep a copy of that or you make sure that your service provider keeps a copy. You will need that for an audit. You would also need it in the case of a DOL, or an IRS audit/investigation. That's one of the first things they are going to ask for. If you do not pass a test. So you failed one or more tests, there are actions that are required to be taken. I won't go into all of those because there's different options depending on a plan setup. Again, your service provider will give you guidance. If you have questions, call them up. Spend some time on the phone with them, but make sure you take action if required. If you don't, and you leave it setting there that's going to cause you problems the next year, because they can't leave it like that. There's this open thing that they can't move beyond, but also if the IRS or DOL were to come in and take a look at your plan and/or your auditor, it could disqualify the plan. Which then would make the plan become taxable to everyone immediately. So obviously it’s a big step. You absolutely do not want that to happen. So it's very important, and these things can get very complicated and are difficult to understand. The best thing to do is follow the instructions. Talk to your service provider. Ask a lot of questions. If you don't understand something don't just say, well, I think this is what they mean and go with it. Make sure you really understand what's needed.

Jamie Nau: So just to clarify, so the consequences sound pretty severe, but it sounds like it's one of those nice professors in college. Where you're allowed to take a test, if you missed to many things you can go back and correct it, right? That's what it sounds like. There's options to go back and do ABC and then you're going to pass the test, it's just the second time through. The other thing I heard you say is you want to make sure the data is correct. So if they give you 10 employees that didn't have hire dates, you could go fill out those hire dates, give them the data back, and they can rerun the test and come out with corrected results?

Kim Moore: That's correct. Yeah, and some depending on the complexity of your plan, the size of your plan, and if you have a lot of highly compensated people or maybe people that get bonuses, commissions, and maybe that fluctuates a lot, providers will also let you kind of do a pre run or preview of that testing ahead of time. That will let you know, because one of the correction methods is that the highly compensated folks have to give money back out of their plan, which a lot of folks don't like. You got to remember, these are the owners. These are the senior executives. These are the people that you really don't want to make mad. So if your provider offers that, it's a good idea to try to take advantage of it. That way you can see ahead of time. There are things that those individuals can do to help prevent that by the time you get to the end of the year. So, again, talk to your service provider, but that is an option. Something you may want to consider.

Jamie Nau: Yeah, definitely. Sounds like something that people need to have a handle on, because the last thing you want to do is tell all your employees that all their contributions are now taxable. 

Kim Moore: Yeah. That would not be not be a smart move. Next area we wanted to talk about was distributions and loans. This is obviously money coming out of the plan. A lot of times these get requested directly by the employee on the website, and the employer has very little to do with them. In and of itself it isn’t that big of a deal. We recommend best practice that you take a look at those just to make sure that you're not seeing something unusual. You know, if you just saw Joe in the hall the other day and Joe was all fine and said nothing, and all of sudden you see that Joe wants one hundred thousand dollar distribution, you might want to just call up Joe and say hey, you know, I saw this. Did you really need this? Not that they can't take the money, but just to protect Joe to make sure that isn't something you got wrong. It could be a fraudster. So we recommend you just take a look at those, double check distributions that are called hardship withdrawals. They are a special category of distributions and there's been some changes around hardship withdrawals. I won't go into all the details around all of that, but that's where a person is taking a distribution, they are still an employee and they need a distribution just as it mentions, for a hardship. So it could be maybe they're getting potentially evicted from their home. They've got problems paying the mortgage. Maybe they had some huge medical bills. It can also be something which isn't really a hardship, but things like going to college. So they need to pay for tuition or books or something like that. So there are some good things they've recently made some changes for. If you're having a child or adopting a child, you could call it a hardship. Depends on how you define it. But there are some changing rules in that space as well. But there's a lot of requirements on the plan sponsor to double check and make sure that it fits the criteria. They're not taking a hardship that's too large, that you're verifying that it's a legitimate request, that they really do need it for whatever the reason is. So, again, my recommendation here, if you get into a hardship request, check with your service provider, because they're going to know the most current rules and whether you plan even allows them. Maybe your plan doesn't even allow hardships because that is optional. So things to check on. Last thing I was going to mention in this space is loans. Plans may allow a participant to take a loan against their account balance or not. Again, optional. So double check. It may not even apply to your plan. If it does then most often we see that, you know, the participant, it's a loan, so they're going to repay the amount that they've taken. Most often they have that set up through payroll. So they may still be making contributions to their plan or they may not. Again, it varies, but you're going to take an additional amount out of their paycheck every pay period to help repay the loan. Along with the interest. So, you know, that can get tricky. You want to make sure that starts up at the right time. You don't want to keep taking funds out of their paycheck once they've paid back the loan, and you're not necessarily going to know that because that's controlled by the service provider. So it's a tricky area. If you've not had a loan before, it's your first one, you might want to give a call to your service provider. Just double check. If you are going through audits on a regular basis and you have a loan for the first time, again, call your auditor and ask for them to walk you through the process. Just be careful, because it can be a little bit tricky. Timing is important. So that’s an area we want to we want to double check.

Jamie Nau: A lot of things you talked about today, it sounds like if a person has a checklist of things they could check for every month, that would be a super easy way to handle these things. So like who became eligible this month? Did we do all the right things? Do we have all the documentation in place? Because, again, we talked last time about the importance of documentation. I think kind of what I'm getting from today is the importance of just doing monthly or quarterly checks just to make sure everything is running exactly as you expected to.

Kim Moore: Absolutely. We put that as a good internal control. It's more than a best practice it’s almost required. If you get a DOL or an IRS audit, or even just a financial statement audit from someone like Summit CPA, that is one of the things we are going to ask. Who is overall responsible for the plan and what are they doing? You know, we don't expect them to go in and be auditing every single transaction, but they do need to just do some general monitoring, make sure things are working the way that they're supposed to. And if they see anything unusual, that's really what they need to pay attention to. 

Jamie Nau: That sounds like an important topic for another podcast, control.

Kim Moore: Yeah. 

Jamie Nau: So before we get to that, I think you have a couple of last items you want to talk about, but I want to make sure our listeners have our e-mail address. So we have an e-mail address that you can send questions to. If you want to get in touch with Kim, or you want us to discuss a topic, we make this show for the listeners. So you can email at: audit@summitcpa.net. We'd love to hear from you guys. So Kim, any final topics from you?

Kim Moore: Yeah absolutely, and I'd like to echo what you just said. Pass along any ideas, something that you're really concerned about. We'd love to do a podcast for you because if you've got a question, there's probably a hundred other people that have the same question out there. The last thing that I had on the list is that there are some disclosures that need to go out. Again, these vary depending on your plan and the different options that you offer as part of the plan. Those need to be distributed. That is another fiduciary requirement. So check with your service provider. Put it on a to do list on your portal that you need to distribute those items. Make sure that you do it. Make sure you get it to the right people, and again, document the date that you did it, who they went to, etc.. Some service providers do that for you and that's fine. But if not, you need to make sure that you're doing it or someone in your HR area is taking care of that. We're coming up on a time when 5500 filings are going to be due. They are for calendar year plans, filing dates are at the end of July. So you're probably going to start hearing about the 5500 questions, and potentially filing. If that's the case for you, make sure that you review the 5500. Take a look. Do not just assume it's correct, because we do find errors on them all the time, even basic things like the name of the plan. There's an EIN number, which is a tax I.D. number. Make sure that's the right number, if that's not right it will cause you all kinds of problems with the IRS and the DOL. So even little things like that, just don't assume they're right. Double check them. Again, you're not an auditor, so you're not going to necessarily audit the form. Just look for obvious mistakes. Make sure it's reasonable. Right Year. The dollar amounts right. Service providers do a pretty good job, but they do make mistakes every once in a while. So double check. I think the rest of the stuff is pretty much internal controls and best practices, and we're going to hit that in a in a future podcast.

Jamie Nau: Awesome. This is really good information. I think these last two podcasts can really set you up for a smooth audit. I think the more findings that happen in an audit, the harder it is to go through, because you have to answer questions. You have to follow up with questions. You have to provide additional support. So the more you are ready for, and know what you should be looking for is super important. So I appreciate you putting all this together.

Kim Moore: Absolutely. I always tell people, if you did something wrong, it's out there and it's just waiting for somebody to find it. It's better for an auditor to find it than the Department of Labor or IRS. Worst case is an employee, because that can have all kinds of bad repercussions to you. But the best thing is to do it right in the first place. Make sure you understand what you need to do. Spend a little bit of time. I know everybody's busy, but it just takes a few minutes to double check a few of these things, and it can save you tons of time and effort, fines and penalties, and everything else in the future. So a little bit of time now is better than a lot of time later on. 

Jamie Nau: Yes, for sure. Thanks again for putting all this together Kim.


Common errors in 401K Audits [Part 2]

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