Qualified retirement plans must file IRS Form 5500. However, only plans that the IRS considers to be “large” need to submit an independent auditor’s report along with their Form 5500 filing.
A “large” plan is an employee benefit plan, 401(k), 403(b), etc. that includes 100 eligible participants at the BEGINNING of the plan year. Eligible participants usually include active participants, as well as employees who have met the eligibility requirements but aren’t participating in the plan, as well as retired, separated or deceased participants with a balance in the plan.
The general rule is that if you have fewer than 100 eligible participants in the plan, you are considered a “small” employee benefit plan. There is one twist that could allow you to avoid the audit requirement – the 80-120 Rule.
The 80-120 Rule lets you file the plan with last year’s status as long as you have between 80 and 120 participants. If you filed as a small “plan”, and you have not exceeded 120 employees this year, you can still file as a small plan and avoid the audit this year.
Should your plan need an audit, here is what to expect and how to prepare:
The first step in the audit process is providing an accurate census to your Third Party Administrator (TPA). For each eligible participant, the census should include birth date, hire date, hours worked, termination date (if applicable), total eligible compensation as defined in the plan document, total employee deferrals and total company matching contributions (if applicable).
Second, gather plan-related documents, which include the executed 401(k) adoption agreement, the basic plan document, the fidelity bond, the IRS Determination Letter, any plan amendments, board and administrative committee minutes in relation to the plan, the 401(k) Summary Plan Description and fee disclosures.
Third, review your internal controls. Many plan sponsors think that if an outside TPA and/or the custodian of the plan’s assets handle their 401(k) plan, then fraud or errors are unlikely to occur. A common challenge for smaller private businesses is that controls are often not prioritized. Expect your auditor to test internal controls and processes relating to transactions made with the plan. 401(k) audits usually involve testing in the following transaction areas: eligibility (i.e. hiring dates and birth dates), contributions/payroll, benefits testing, payroll remittance testing, investment allocation testing, and expense testing, as well as rollover contribution testing and participant loan testing.
The end result of the audit process is a complete set of financial statements. The financial statements will be attached to your Form 5500 and submitted with your electronic filing to the Department of Labor annually. Additionally, your auditor will provide you with recommendations to help improve plan processes and efficiencies based on your audit results.