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401(k)/403(b) Audit Requirements/Quality Study Results

The Employee Retirement Income Security Act of 1974 (ERISA) sets requirements for plan sponsors of 401(k) and 403(b) plans to help protect the interests of the participants and beneficiaries of these plans.  Among many items established by ERISA, certain plans are required to have annual audits performed on the plan’s financial statements by an independent certified public accountant. IRS penalties for late filing of a properly prepared 5500 tax return are $25 per day, up to a maximum of $15,000.  In addition, Department of Labor penalties can run up to $1,100 per day, with no maximum. To avoid these penalties, you need to know if your plan requires an audit.

To begin, plan administrators should know the “80-120 participant rule”. Plans are allowed to file Form 5500’s to the IRS as small plans, and do not require an audit, as long as their plan does not exceed 120 eligible participants on the first day of the plan year. While it is unheard of, an administrator could elect to have an audit with as few as 80 participants. Once the plan has exceeded 120 eligible participants at the beginning of a plan year, the plan is considered to be a large plan and must have annual audits completed in succeeding years. If the plan would ever fall below 100 eligible participants at the beginning of a following plan year, the plan could then again file as a small plan and no audit would be required. The terminology of the 80-120 participant rule is extremely important. A business can easily have 120 or more eligible participants but have less than 120 current employees.

So what is an eligible participant? Eligibility includes current employees who are eligible for the plan (including those who are not participating!) as well as former employees who have a balance in their account. Plan eligibility requirements vary plan to plan. Eligibility often depends on age and time of service requirements. However, for some plans, eligibility includes every employee if no prerequisites were elected as part of the adoption agreement. All plan administrators should be knowledgeable of their plan’s definition of eligibility and should constantly monitor the number of “eligible participants” to ensure they do not require annual audits.

For those plans that do require annual audits, audited financial statements are required to be submitted with the Form 5500, Annual Return of Employee Benefit Plans, on the last day of the seventh month after the plan year end. There is an optional extension of 2 ½ months.

As mentioned earlier, ERISA was established to protect the interests of the plan’s participants. This is why the US Government requires the audit—even though it is often viewed as an expense burden. However, a recent study by the Employee Benefits Security Administration, along with the Department of Labor, found that nearly 4 out of 10 audits contained major deficiencies by the CPA firms conducting the audits.  The study also found there is a direct correlation between the number of audits a firm performs annually and the deficiency rate. The report found CPA firms which perform only 1-2 employee benefit plan audits annually had a 76% deficiency rate compared to only a 12% deficiency rate among the firms which specialize in employee benefit plan audits.

As plan administrators of your 401(k) and 403(b) plans, it is your responsibility to protect the financial interests of the plan’s participants. Be sure to select auditors who are qualified and understand the importance of quality audit work. At Ketel Thorstenson, LLP we partake in annual employee benefit plan trainings, are members of the Employee Benefit Quality Center, and have the experience of auditing more than 40 employee benefit plans annually.

If you are interested in knowing more about 401(k) or 403(b) plan audits, or have any questions about Ketel Thorstenson’s employee benefit plan practice, please contact my direct line at 605-716-3259.

Austin Eichacker

Austin is a dedicated Certified Public Accountant with experience in audit, compilations and reviews. He serves as a Manager in the Audit Department in the Rapid City office. He specializes in commercial retail, casinos, and retirement plan audits.
Austin Eichacker

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401(k), 403(b), Employee Retirement Income Security Act (ERISA)

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