As a company grows, the federal requirements for 401(k) plan reporting can change, prompting a partnership with a Certified Public Accountant (CPA) firm. Companies that are experiencing their first large plan audit can be caught unaware and therefore unprepared to undergo a detailed examination of plan compliance, internal controls, and industry best practices.
Although there are numerous components to the 401(k) audit that can be complex for first-time organizations, the information your business receives from the auditing process can help you gain insight into the plan sponsor’s fiduciary responsibilities and any potential errors.
What is a 401(k) Audit?
In short, a 401(k) audit is the process by which an independent certified public accountant investigates the financial standing of a defined contribution retirement plan. The audit seeks to verify the plan’s compliance with certain government regulations and plan-related documents, as well as determine the accuracy of the financial information.
The process can be time-consuming and grueling if the organization being reviewed is unprepared. A 401(k) audit typically takes 6-8 weeks to complete and includes an information request stage, interviews, and a preliminary client review before the report is finalized. However, there are many steps your business can take to expedite the auditing process.
When Do You Need an Audit?
According to the Employee Retirement Income Security Act of 1974 (ERISA), annual audits of plan financial statements are required for organizations with 100 or more eligible employees. Typically, employees that are 21 years of age and have worked at the organization for at least one year are eligible, however this depends on what the plan document states. It’s important to note that employees who’ve met eligibility requirements, but don’t actively participate in the plan and employees who have been terminated, but still have balances in the plan on the first day of the plan year are counted toward the overall size with regard to the audit requirement and are considered participants.
Plans that are subject to audits must report certain information to federal government agencies such as the Department of Labor (DOL), the Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation (PBGC) on a yearly basis.
80 – 120 Rule
Small plans are subject to less extensive scrutiny, and as a result, many businesses try to keep their small plan status for as long as possible. This is where the 80 – 120 rule can allow some flexibility for businesses with fluctuating employee numbers. Under the 80 – 120 rule, businesses that have between 80 – 120 plan participants at the beginning of the plan year are able to file the same form as the previous year. Once your company reaches more than 120 participants, your organization’s 401(k) plan will become classified as a large plan and therefore subject to annual audits. After you have triggered the audit requirement by going above 120 employees, the plan size must drop to below 100 participants on the 1st day of the plan year before the audit requirement would no longer be in place.
A crucial element to a complete 401(k) audit is the submission of Form 5500, also known as the Annual Return/Report of Employee Benefit Plan. Administrators of a large plan must file the form with the IRS and DOL to disclose information pertaining to the “qualifications of the plan, its financial condition, investments, and the operations of the plan.” The Form 5500 must be submitted with the audit report and has the same deadline as large plan audits.
Filing Deadlines, Extensions, and Fees
Large plan audits need to be completed seven months after the end of the plan year. For businesses that operate on the calendar year with a plan that ends on December 31st, the deadline to submit the independent accountants report and financial statements delivered at the end of the auditing process alongside Form 5500 is July 31st. Luckily for businesses that know they will not be able to make the regular deadline, there is an option to request a two and a half month extension. This would bring the final filing date to October 15th (for plans on the calendar year).
If a business requests an extension and still fails to meet the deadline, the fees and penalties can quickly add up. The IRS charges $25 each day the documents are late with a maximum of $15,000 for late filing. The DOL fees are much higher, costing businesses up to $1,100 each day with no mandated maximum for late filing.
401(k) Audit Process
To perform a 401(k) plan audit, an audit team will follow a series of steps that can seem daunting for organizations that are being processed as a large plan for the first time. Businesses can streamline the process by having the necessary documents ready.
The 401(k) audit steps usually involve:
- The organization being audited will need to request the audit package from a third party record keeper, then grant the designated auditor access to those documents. The organization will also need to provide all of the plan-related documents, such as the IRS determination/opinion letter, the plan document, adoption agreement and any amendments made to the original plan document.
- The auditor will schedule a fieldwork date once they have received the necessary information to meet the plan administrators’ onsite. This process can also be conducted remotely after the first year, but the overall goal of obtaining insight into the plan accounting processes, internal controls, and fraud risk remains the same.
- Plan Management will need to draft the financial statements using generally accepted accounting principles. Your auditor can provide example financial statements which can be used as a guide to prepare the financial statements. You can engage the auditor to help with the financial statement preparation, however in order for the auditor to remain independent, someone in management with the necessary skills and experience must review the financial statements and accept responsibility for them.
- A sample of employees, distributions, and loans will be chosen by the auditor for closer inspection. The auditor may also request employee files and supporting documents.
- Once the auditor has completed their audit, they will provide the organization with an updated draft of the financial statements as well as a draft of a report detailing any control deficiencies that were observed. Alongside these documents, the auditor will submit a management representation letter that will need to be signed and returned.
- After the management representation letter has been returned and the organization approves the draft of the financial statements, the auditor will produce the final independent accountants report and financial statements which can then be filed with the necessary government entities.
Identify Fraud, Noncompliance, and Financial Reporting Errors
The DOL is incredibly strict when it comes to ensuring that 401(k) plans are being operated in accordance with the provisions of the plan documents. 401(k) audits usually involve testing in a diverse range of transaction areas like eligibility, contributions/payroll, investment allocation testing, benefit testing, payroll remittance testing, and expense testing to ensure that an organization remains compliant with IRS and DOL regulations.
One of the primary purposes of a 401(k) audit is to protect employee benefit plans from fraud. It is the job of the independent auditor to identify instances of asset misappropriation, which can be an accidental oversight or intentional, along with more serious instances of fraudulent financial reporting. There are a number of red flags that regulators are focused on, including:
- Improper valuation of investments
- Incorrect vesting of plan participants
- Ineligible participants taking part in the plan
- Improper benefit disbursements
- Timely remittance of employee contributions
Having documents readily available and organized prior to working with a licensed auditor, can help to streamline the 401(k) auditing process.
To make sure your organization’s 401(k) plan is compliant with IRS and DOL standards and free of any errors that might affect participants’ benefits, you need an objective, experienced third-party CPA firm. At K Financial, our team of qualified auditors can provide you and your employees with regulatory and financial peace of mind.