Understanding the Audit Requirements for 401(k) Plans: A Guide for Small Businesses
If your business is growing, do you know the point at which you will require a 401(k) plan audit or other type of employee benefit plan audit? Understanding your requirements is crucial for maintaining compliance and safeguarding the retirement savings of your employees. We want to help you approach the audit process with confidence and clarity. In this article, we will cover the requirements for 401(k) plans, which are similar requirements to other employee benefit plans, in a way that gives small business owners and plan administrators insight into this essential aspect of employee benefit management.
Before you start reading this, ask yourself: Is your small business ready to tackle what's needed for 401(k) audits, or are you worried about falling victim to hidden pitfalls?
Key Takeaways
We'll share what triggers a 401(k) plan audit and how to prepare for it
We'll talk about the important role audits play in protecting employee interests and enhancing plan performance
We'll cover the critical elements of a plan audit - but, if you're looking for a checklist, you can find it here
We'll discuss common audit findings and strategies to avoid them
We'll familiarize you with Form 5500 filing requirements
What is a 401(k) Audit?
To put it concisely, a 401(k) audit is a review of a company's 401(k) plan to ensure it complies with necessary regulations set by the IRS and the Department of Labor (DOL). A third-party accounting firm conducts these to ensure 401(k) plans are being operated correctly. Information from a company's Form 5500 and financial statements related to the employee benefit plan are reviewed during the audit. These must be completed before the Form 5500 filing deadline and can take several weeks to a few months to finish.
Who Needs a 401(k) Retirement Plan Audit?
Businesses that have over 100 eligible employees at the beginning of the year are required to get a 401(k) audit. However, the first time this requirement will be triggered is when an organization has over 120 employees eligible for the employee benefit plan. This doesn't mean that all employees have to participate to be counted in that number. Once a business has over 100 eligible employees, the 401(k) is considered a "large plan" and requires the long form of 5500 plus an audit. There is also something called the 80-120 participant rule. Companies that have over 100 eligible employees, but filed as a small plan in the previous year, can file again as a small plan in the current year if they have between 80-120 eligible employees.
So, remember those three numbers: 80, 100, and 120.
Types of 401(k) Audits
There are two different types of 401(k) audits – the limited scope and the full scope.
The most common type of 401(k) audit is the limited-scope audit. It doesn't include an audit of investments or investment activity, and is more about compliance with the plan document. If the governance of the plan abides by what is outlined in the plan document, the limited-scope audit will go well. Because this is less comprehensive, the limited-scope audit is also more affordable. However, not everyone is eligible for this type of audit. To find out if you are, ask your asset custodian for a certification on the assets. The party issuing the certification would be an insurance company, a bank, or a similar entity. Certifications that are approved open the door for limited-scope audits.
Full-scope audits require more details and procedures. They are more time-consuming and require more work, but firms like OAK Advisors can help you sort out complexities and guide you on the documents and information required.
Common Problems Found During 401(k) Audits
Data inconsistencies often surface as a common issue during 401(k) audits. If data is inconsistent in plan documents, this can cause compliance risk and lead to audit findings - essentially, a weakness or deficiency noticed in the plan.
To reduce the likelihood of audit findings, plan administrators and business owners should conduct regular data reviews and maintain consistent record-keeping practices. Robust data management systems can greatly reduce the likelihood of errors.
Another common audit finding stems from late contribution deposits. 401(k) plans need to make timely deposits to maintain compliance with regulations. Late deposits can result in penalties. One thing businesses can do to avoid this finding is to set up automated systems that guarantee on-time deposits. Before a 401(k) audit is needed, small plans on their way up should conduct regular internal audits to identify and solve any timing issues.
A third common audit issue comes from inadequate plan documentation. All plan documents should be complete and up-to-date. This helps demonstrate compliance and provides a clear audit trail.
At the end of the day, businesses are responsible for keeping track of all plan-related documents, so it's important for business owners to understand which entities are recording what information, and what pieces may be falling through the cracks. Communication gaps between the payroll provider and the recordkeeper can also pose issues. To learn more about what can be requested, check out our employee benefit plan checklist post. If you're still in the small plan category, knowing this list will mean you'll be ready before an audit is even required.
Components of a 401(k) Audit
Once a business confirms with their third-party administrator (TPA) that an audit is required, an outside CPA firm, like OAK Advisors, will be able to conduct the audit. Most of the information that the audit firm will require will come from the TPA, while some of it may come from HR.
You'll start with a meeting that covers all of the steps in the audit, as well as a list of what needs to be compiled to conduct the audit from the TPA, HR, and potentially the investment advisor. You'll also reach a fee agreement for the scope of the audit. The audit package required from the recordkeeper will help move the process along and will contain contribution records, participant data, and investment information.
The auditor, upon receiving the audit package, will select specific data points and conduct further examination, which will require further communication with the TPA or recordkeeper for additional documentation. As a rule of thumb, expect 3-4 months from start to finish. Consider how these align with key dates for plans that align with the calendar's year-end:
January 31: Employee census is submitted to the TPA
March 15: TPA will confirm whether a company is in audit status
July 31: Deadline for Form 5500 and audit completion
October 15: Extended deadline
In general, a 401(k) audit is assessing the following:
Accuracy and compliance of balance sheets and income statements
Adherence of the plan to outlined, documented terms for eligibility, contributions, and distributions
Effectiveness of internal controls to ensure plan operations are securely and reliably conducted
Form 5500 Filing Requirements for Plan Audits
Most 401(k) plans, regardless of size, are required to fill out Form 5500, an essential annual report that is filed with the Department of Labor (DOL). This form summarizes the financial condition and operations of the 401(k) plan. Small businesses must ensure that the information is accurate and submitted on time to avoid penalties.
When you obtain a 401(k) audit, the audited financial statements will be sent with Form 5500, as well as any necessary attachments, which can include notes from the audit and schedules. Auditors can help you prepare these attachments to ensure you are sending what is necessary with the form.
Businesses that miss filing for Form 5500 can result in significant penalties, so it's important to get everything filed in time or ask for an extension.
How to Select a CPA for Plan Audits
Whether you need a 401(k) audit or another type of employee benefit plan audit, the process with the right CPA will essentially be the same. However, not all CPA firms are created equal. You want to choose an accounting firm that is reachable, reliable, and experienced. One of the most time-consuming parts of a 401(k) audit can be the back-and-forth communication around necessary documentation. Any delays on the side of the auditor can lead to last-minute submissions or filing extensions. To experience a smooth audit process, look for a CPA who is approachable and responsive to your emails.
OAK Advisors CPAs has seen clients experience this frustration with other firms, which is why we have chosen to bill ourselves as the Most Reachable Firm* (*within reason). We will respond to client emails within a reasonable time frame. That way, you aren't left waiting, wondering whether our team is working on your audit. You know what we're doing and you benefit from that transparency every step of the way.
Learn more about our 401(k) audits and contact us today to work with a member of our team. Our audit experts can help simplify the most complex of audit practices.