In 1974 Congress passed the Employee Retirement Income Security Act (ERISA) which governs 401(k) plans. It requires any private employer that establishes and maintains a 401(k) plan to meet certain standards in order to benefit from the tax advantages of the plan. One standard that must be met for larger plans is a plan audit.
A plan audit is a review of a company’s qualified retirement plan by a third party Independent Certified Public Accountant. The audit ensures the plan is adhering to Department of Labor and ERISA regulations. Auditors review information provided on a plan’s Form 5500 and financial statements to verify accuracy. They determine whether the plan fulfills its fiduciary responsibilities and whether an employer is operating its plan correctly. They also identify possible operational errors and potential fraud risks.
How do you know if your 401(k) plan will require a plan audit?
Administrators of a 401(k) plan subject to ERISA must file an annual report called the Form 5500. This publicly available return provides statistical and financial information about the plan.
The plan will file as either a “large plan” or a “small plan.” Generally, a large plan covers 100 or more eligible participants; a small plan covers less than 100 eligible participants
How those participants are counted, however, is complex.
With the passing of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), the DOL decided to count participants with account balances at the start of the plan year, rather than counting those who are eligible to participate. This affects plans beginning on or after January 1, 2023. This change in counting methodology allows smaller plans that formerly were required to have an audit to waive the requirement. This reduces the expenses for small plans and encourages more small employers to offer a retirement savings plan to their employees.
The DOL regulations also include an 80/120 Rule that allows a plan to continue filing as either a large or small plan even when the participant count fluctuates. For example, if a plan has been filing as a small plan and its participant level rises above 99 but not above 120, it may continue to file as a small plan. If the count does not exceed 120, there is no limit on the number of years an employer may use this exception. Once the plan count exceeds 120 participants at the beginning of the year, it will be subject to the large plan audit requirements.
A plan eligible for the 80/120 rule usually takes advantage of it because it means less costly filing fees and it allows them to avoid the plan audit requirement.
Once a small plan files as a large plan, it cannot subsequently file as a small plan using the transition rule, even if the participant count drops below 100. If the participant count drops below 80, then the plan must file as a small plan. Why is the magic number 100 yet 80 and 120 are the limits? A newly established plan with a participant count greater than 99 must file as a large plan.
For large plans requiring an audit, the audit report must be attached to the completed Form 5500 and must be electronically filed with the IRS by the end of the seventh month following the plan year-end (July 31 for calendar year-end plans). An extension may be filed if needed to extend the filing date by two-and-a-half months behind the regular deadline (October 15 for calendar year-end plans).
If a large plan does not include an independent audit report with the Form 5500 filing, it is treated as if the Form 5500 was never filed. This can result in significant monetary penalties assessed by both the IRS and the DOL and may affect your plan’s qualified status.
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