Hey there! Ever wondered about the inner workings of your company's 401(k) plan? Specifically, when does it get the full once-over by an auditor? You're in the right place! Understanding the rules around 401(k) audits is crucial for any business owner or plan administrator. It's not just about avoiding penalties; it's about safeguarding your employees' retirement futures. Let's dive in and demystify the participant count that triggers a 401(k) audit, along with a comprehensive guide on what it all means for you.
How Many Participants to Trigger a 401(k) Audit: A Comprehensive Guide
A 401(k) audit is a thorough examination of your company's retirement plan to ensure it complies with the stringent regulations set forth by the Employee Retirement Income Security Act (ERISA), as well as rules from the Internal Revenue Service (IRS) and the Department of Labor (DOL). It's a critical process designed to protect plan participants and ensure the plan is being administered fairly and accurately.
Step 1: Engage with Your Plan's Pulse - Understanding the Core Threshold
So, you're curious about the magic number, right? The general rule of thumb for when a 401(k) plan needs an audit is when it reaches 100 or more participants with account balances on the first day of the plan year. This is a crucial detail!
What Does "Participants with Account Balances" Mean?
For plan years beginning on or after January 1, 2023, the definition of a "participant" for audit purposes has become clearer. It solely refers to individuals who have an account balance in the plan as of the first day of the plan year. This includes:
Active employees who are contributing or have a balance.
Former employees who still have a balance in the plan.
What it generally doesn't include (as of 2023 onwards) are employees who are merely eligible to participate but haven't yet contributed and therefore don't have an account balance. This change was made to potentially reduce the audit burden for some smaller plans.
Why the 100-Participant Mark?
The Department of Labor (DOL) classifies plans with 100 or more participants as "large plans." Large plans are subject to additional reporting requirements, including attaching an independent qualified public accountant's (IQPA) audit report to their annual Form 5500 filing. This audit provides an extra layer of scrutiny to ensure the plan's financial statements are accurate and that the plan is operating in compliance with ERISA.
Step 2: Navigating the Nuances - The 80/120 Rule and Other Considerations
While the 100-participant threshold is the general rule, there are important exceptions and considerations that can impact whether your plan needs an audit.
The 80/120 Rule: Your Potential Lifeline
This is a significant rule that can help some plans avoid an audit, at least for a period. If your plan has between 80 and 120 participants on the first day of the plan year, and you filed as a “small plan” in the previous year (meaning you did not require an audit), you may be permitted to continue filing as a small plan and avoid the audit until your participant count exceeds 120.
Example: If your plan had 90 participants on January 1, 2024, and filed as a small plan for 2023, and then on January 1, 2025, it increased to 105 participants, you could still file as a small plan for the 2025 plan year and defer the audit requirement. However, if in 2026 your count goes to 125, you would then be required to have an audit.
Short Plan Year
If your plan year is seven months or less (e.g., due to a change in plan year-end), you may be able to defer the audit for that short period. Always consult with your plan administrator or a qualified professional in such cases.
Involuntary Cash-Out Provisions
Many plan administrators are surprised to learn that allowing former employees to keep small balances in the plan can trigger an audit. If your plan document has an "involuntary cash-out" provision, you should review it. This provision allows the plan to distribute small vested balances to former employees without their written consent (typically below a certain dollar threshold, like $5,000 or $1,000, depending on the plan document). By actively cashing out these small balances, you can potentially reduce your participant count and stay below the audit threshold.
Step 3: Proactive Vigilance - Monitoring Your Participant Count
Don't wait for a surprise! Regularly monitoring your participant count is a crucial best practice.
Sub-heading: When to Check Your Participant Count
The most critical time to determine your participant count for audit purposes is on the first day of your plan year. For most calendar-year plans, this means January 1st. Make it a habit to obtain a detailed report from your plan administrator or recordkeeper at the very beginning of each plan year.
Sub-heading: How to Get an Accurate Count
Your payroll provider and plan recordkeeper are invaluable resources for this. They can typically generate a list of all participants with account balances as of your plan year's start date. Ensure this list is accurate and includes all individuals with a balance, even if they are no longer employed.
Step 4: Preparing for the Inevitable - What a 401(k) Audit Entails
If your plan crosses the threshold and an audit becomes necessary, don't panic! Preparation is key to a smooth process.
Sub-heading: Documents You'll Need to Gather
Auditors will require a comprehensive set of documents to review. Start gathering these well in advance:
Plan adoption agreements and any amendments: These are the foundational legal documents of your plan.
Summary Plan Descriptions (SPD) and Summary of Material Modifications (SMMs): These communicate plan rules to participants.
Payroll records: To verify contributions, compensation, and eligibility.
Participant deferral elections: To ensure contributions match elections.
Investment statements: To confirm asset balances and transactions.
Drafts of Form 5500: For the current and potentially prior years (especially if it's your first audit).
Details about your internal processes and information systems: How you administer the plan, handle contributions, distributions, etc.
Discrimination testing results and supporting details: Proof of compliance with non-discrimination rules.
Evidence of ERISA bond coverage: Demonstrating protection against fraud or dishonesty.
Service provider contracts: With your recordkeeper, third-party administrator (TPA), investment advisor, etc.
Minutes of fiduciary meetings: Documenting decisions related to the plan.
Sub-heading: Understanding the Audit Process Flow
A typical 401(k) audit follows several stages:
Initial Planning and Document Collection: The auditor will have a kickoff meeting to understand your plan's setup and administration. They will provide a list of requested documents.
Testing and Internal Review: The auditor will examine the collected documents, verify data, and test compliance with plan provisions and regulations (e.g., timely deposit of contributions, proper application of eligibility rules, accurate calculation of contributions and distributions).
Final Audit Report and Filing: Once the audit is complete, the auditor will issue a report, which includes financial statements and an opinion on the plan's compliance. This report is then attached to your Form 5500 filing.
Step 5: Avoiding Common Pitfalls - Lessons from First-Time Filers
Many businesses encounter similar issues during their first 401(k) audit. Being aware of these can save you a lot of headaches.
Sub-heading: The Dreaded Participant Miscount
This is perhaps the most common error. As discussed, the definition of a participant for audit purposes is specific. Don't just count active employees; remember former employees with balances.
Sub-heading: Assuming Your Provider Does Everything
While your recordkeeper and TPA handle many aspects of plan administration, the ultimate fiduciary responsibility rests with the plan sponsor. Don't assume their reports are all that's needed for an audit. You need to understand your own processes and documentation.
Sub-heading: Waiting Until the Last Minute
Audits take time! The Form 5500, with the attached audit report, must generally be filed by the last day of the seventh month after your plan year-end (e.g., July 31st for a December 31st year-end), with a possible extension until October 15th. Start preparing and engaging an auditor well in advance. Rushing the process can lead to errors and penalties.
Step 6: Choosing Your Partner - Selecting a Qualified Auditor
The quality of your audit heavily depends on the expertise of your auditor.
Sub-heading: Key Qualifications to Look For
Employee Benefit Plan (EBP) Audit Expertise: Not all CPAs are created equal when it comes to 401(k) audits. Look for a firm with demonstrated experience and a dedicated EBP audit practice.
AICPA Membership: Membership in the American Institute of Certified Public Accountants (AICPA) indicates adherence to professional standards and ongoing training. Many firms specialize in EBP audits and are peer-reviewed for this specific area.
Independence: The auditor must be independent of your company to ensure an unbiased review.
References: Ask for references from other plan sponsors they have audited.
Communication Style: Choose an auditor who communicates clearly, explains the process, and is responsive to your questions.
Step 7: Post-Audit Action - What Comes Next
The audit isn't the end of the journey. It's an opportunity for improvement.
Sub-heading: Reviewing Findings and Recommendations
Your auditor will present their findings. These might include:
Opinion Letter: The auditor's formal opinion on the plan's financial statements. An "unqualified" opinion is the best, meaning the financial statements are presented fairly in all material respects.
Management Letter: This outlines any internal control deficiencies or operational findings and provides recommendations for improvement.
It is crucial to take these findings seriously and develop a plan to address any identified issues. The IRS and DOL have correction programs (like EPCRS and VFCP) for various types of plan errors.
Sub-heading: Implementing Corrections and Best Practices
Work with your TPA, recordkeeper, and legal counsel (if needed) to implement any necessary corrections. This might involve:
Making missed contributions to participant accounts.
Adjusting payroll or contribution processes.
Updating plan documents.
Enhancing internal controls to prevent future errors.
Holding regular fiduciary meetings and documenting decisions.
Frequently Asked Questions (FAQs)
Here are 10 common questions related to 401(k) audits:
How to Determine Your 401(k) Participant Count for an Audit?
To determine your 401(k) participant count, obtain a report from your plan recordkeeper or payroll provider as of the first day of your plan year, specifically counting only individuals with a positive account balance.
How to Apply the 80/120 Rule for 401(k) Audits?
If your plan had between 80 and 120 participants with account balances on the first day of the plan year and filed as a "small plan" (no audit required) in the previous year, you can continue to file as a small plan for the current year.
How to Prepare for Your First 401(k) Audit?
Start by gathering all plan-related documents, including plan agreements, SPDs, payroll records, investment statements, and service provider contracts. Familiarize yourself with common audit issues and consider a "mock audit" or internal review.
How to Choose a Qualified 401(k) Auditor?
Look for a CPA firm with extensive experience in Employee Benefit Plan (EBP) audits, an AICPA membership, and a strong reputation for independence and clear communication. Ask for references and verify their expertise.
How to Avoid a 401(k) Audit (Legally)?
The primary legal way to avoid an audit is to keep your participant count (those with account balances) below 100 on the first day of your plan year, potentially leveraging the 80/120 rule or actively utilizing involuntary cash-out provisions for small balances of terminated employees.
How to Ensure Timely Deposit of 401(k) Contributions?
Establish clear processes and internal controls to ensure participant contributions are segregated from company assets and deposited into the plan trust as soon as administratively feasible, but no later than the 15th business day of the month following the payroll deduction.
How to Correct Common 401(k) Audit Findings?
Utilize IRS and DOL correction programs (like EPCRS for IRS issues and VFCP for DOL/ERISA issues) to voluntarily correct errors such as missed contributions, improper eligibility, or incorrect deferral limits. Work with your TPA and legal counsel for guidance.
How to File the Form 5500 with an Audit Report?
Once your auditor issues their report, it must be attached to your completed Form 5500. This entire package is then filed electronically with the Department of Labor by the specified deadline (typically July 31st for calendar year plans, with an extension available until October 15th). Your TPA or auditor often assists with this filing.
How to Understand "Participant with an Account Balance"?
For plan years starting on or after January 1, 2023, a "participant with an account balance" refers to any individual (active or former employee) who has a positive monetary balance in their 401(k) account on the first day of the plan year. This is the sole criterion for counting.
How to Stay Compliant with 401(k) Regulations Annually?
Regularly review your plan document, conduct internal reviews of your administrative processes, keep meticulous records, stay informed about changes in IRS and DOL regulations, and work with experienced service providers (TPA, recordkeeper, auditor).
