November 20

The Ultimate Guide to a 401(k) Audit

Ask anyone who’s ever been responsible for 401(k) administration: the annual 401(k) audit is no walk in the park.

The 401(k) audit is the extensive, complicated annual compliance review process required for any 401(k) plan with over 100 participants. This involves pulling reports, gathering documents, and lots of back-and-forth with auditors. As your plan design increases in complexity, so does the risk of major financial penalties.

In this article, we’ll cover all the important points so you can prepare early for the quickest, most pain-free 401(k) audit possible.


What is a 401(k) audit?

The 401(k) plan audit is mandated by the Employee Retirement Income Security Act (ERISA). The goal of an audit is to make sure that your plan is in compliance with government regulations, and that it’s free of mistakes that may affect participant benefits. It's also usually the biggest, most complex, and most time-consuming part of the 401(k) administration process.

A 401(k) audit will verify two key pieces of information:

  1. That your 401(k) plan is compliant with Department of Labor (DoL) and Internal Revenue Service (IRS) regulations
  2. That your 401(k) plan is within the specific guidelines of the plan documents

It’s typically done by an independent qualified public accountant or a third-party vendor. The audit can reveal any parts of the plan that aren’t in compliance. You’ll have the opportunity to take the proper steps to fix things, thereby minimizing risks to your employees and your company.


When must a 401(k) plan be audited?

If you have 100 or more eligible participants in your company’s 401(k) plan, you’ll need to complete an audit. Your 401(k) audit is submitted along with the plan’s Form 5500.

However, even if you do have 100 participants, there is a chance that you won’t need to complete an audit for this year. Check to see if your plan qualifies for the 80-120 participant rule. 


The 80-120 Participant Rule

The 80-120 participant rule allows you to defer an audit until you begin a plan year with 121 or more eligible participants. 

So, while your plan will be considered a large plan at the 100-participant threshold, you could defer your audit as long as you have between 80 and 120 participants. If you filed as a small plan last year, and you haven’t exceeded 120 employees this year, you can still file as a small plan and avoid the audit this year.

Once your plan is considered a large plan and you've crossed the 120 eligible participant threshold, you will not be able to avoid audits in the future unless your eligible participant level dips below 100.


What is the cost of a 401(k) audit?

You must hire a third party administrator (TPA) to carry out your 401(k) audit. The specific cost is difficult to predict, since it depends largely on the size of the 401(k) plan being audited and the complexities of the situation. The third party administrator you hire should assess the situation and what it requires and provide a quote that’s commensurate with the job.


401(k) Plan Checklist

Every year, it’s important that you review the requirements for operating your 401(k) retirement plan. Here’s a handy checklist to help you keep your plan in compliance with many of the important rules.

Has your plan document been updated within the past few years?

If your plan hasn’t been updated to reflect recent law changes, the plan needs to be revised.

Are the plan operations based on the plan document terms?

Failure  to follow the terms of the plan is a common problem found on audit.

Is the plan’s definition of compensation for all deferrals and allocations used correctly?

Your plan may use different definitions of compensation for different purposes. It’s important that you apply the proper definition found in your plan document.

Were employer matching contributions made to appropriate employees under the plan terms?

The plan terms must be followed when allocating employer matching contributions.

Has the plan satisfied the 401(k) ADP and ACP nondiscrimination tests?

Most 401(k) plans must satisfy yearly ADP & ACP nondiscrimination tests.

 

Were all eligible employees identified and given the opportunity to make an elective deferral?

By supplying your tax advisor with information regarding all employees who receive a Form W-2, you may reduce the risk of omitting eligible employees.

Are elective deferrals limited to the IRC Section 402(g) limits for the calendar year?

Failure to distribute deferrals in excess of the 402(g) limit may result in additional taxes and penalties to the participant and employer.

 

Have you timely deposited employee elective deferrals?

You should deposit deferrals as soon as they can be segregated from the employer’s assets.

Do participant loans meet the plan document and IRC Section 72(p) requirements?

Defaulted loans or loans in violation of IRC Section 72(p) may be treated as a taxable distribution to the participant.

Were hardship distributions made properly?

If a plan allows hardship distributions, the plan terms must be followed.

Were top-heavy minimum contributions made?

If the plan is top-heavy, minimum contributions for non-key employees are required.

Was Form 5500 filed?

Many 401(k) plans must make an annual filing with the federal government.

If you answered “no” to any of the above questions, you may have made a mistake in the operation of your 401(k) plan. Contact your 401(k) Advisor for more assistance.


401(k) Audit Process

Now that we’ve covered the important basics, let’s cover the audit process as it matters to you.

  1. An auditor will review your company’s documentation and compliance.
  2. The auditor will conduct an analysis to make sure your plan is operating within the guidelines of your plan-related documents.
  3. The auditor will review your plan to ensure it follows specific DoL and IRS regulations.

Step 1: Review the plan document & design

The Auditor’s goal: They will look for the following information to get a broad overview of your 401(k) operation:

  • The plan document, which includes design and rules
  • The 401(k) operation, including the controls that are in place to ensure that it’s being run correctly
  • The definition of compensation that’s eligible for 401(k) contributions (for instance, 401(k) contributions might only be based on W-2 compensation)
  • Financial data on contributions, loans, rollovers, or other transactions made during the plan year

The Plan Administrator’s goal: Gather the initial documents needed for the audit into an “Audit Packet,” which goes straight to the auditor.

(Prepare yourself: You’ll need to gather a small mountain of documents for your 401(k) audit. Some papers come from the employer, and others come from the recordkeeper and/or custodian.)

Here’s a quick checklist of what 401(k) auditors usually ask for.


401(k) Audit Documents Checklist

Plan Documents

From Payroll

From Recordkeeper
  • Recordkeeper SOC1 Report
  • Custodian SOC1 Report
  • Draft Form 5500
  • Participant Contribution Report
  • Certification Statement vs. Trust Reconciliation Report
  • Executive Summary Report
  • Loan Report
  • Custodian Statement
  • Recordkeeper Register Total Report
  • Recordkeeper Register Detail Report
  • Compliance Testing Package (top heavy, ADP, ACP, 410b, 402g, etc. results)
  • Rollover Report
  • Distribution Report

Are you going through your first 401(k) audit?

Here's a tip on how to make this step go smoothly in the coming years.

Absent major changes in the plan, the list of documents auditors need is often similar year-to-year. So always be sure to note where the documents came from. Or, even better, keep your documents well-organized in one easy-to-reach place so you don’t have to spend time digging through filing cabinets or chasing down documents from other departments.

Once you’ve handled all the auditor’s initial requests, the bulk of the work begins in step 2.


Step 2: 401(k) Deposit Review & Participant-Level Sampling

The Auditor’s goal: To analyze all the crucial details about benefit plan financial transactions and employee plan participation. 

This information is reported in two spreadsheets:

  1. The 401(k) Deposit Report (also known as the Cash Transfer Report)
  2. Participant-Level Requests

The Plan Administrator’s goal: Fill in the information required in these two essential spreadsheets. Here’s what's required from you for each:


401(k) Deposit Report

This is essentially a focused look at the money deposited into the plan. In this report, the auditor is looking for…

  • Transmission times. How long did it take to transfer contributions from payroll to the 401(k) provider?
  • Transmission amounts. Are there any discrepancies between the amounts reported in payroll and the 401(k) provider?

Putting together this report can be a tiring and tedious process for plan administrators, because getting the information for this report usually means pulling one report from payroll AND one report from the recordkeeper for every date that you ran payroll.

Every. Single. Date.

That adds up to a lot of data. If you have a bi-weekly payroll schedule, you'll have to pull 52 reports just to fill in this spreadsheet. That also doesn't count any off-cycle payroll runs you might have for bonuses, missed payments, or reimbursements.


Participant-Level Sampling

This is data that the auditor needs from a random sampling of participants. In this report, the auditor is looking for documentation that proves the following 401(k) processes were done correctly:

  • Payroll
  • Employee eligibility & enrollment
  • Calculation, transfer, and allocation of participant contributions
  • Incoming rollovers
  • Distributions
  • 401(k) loans
  • Any payments or disbursements made by the plan

Oftentimes, the requested documentation is really specific HR documents such as offer letters, signed loan requests, and screenshots from payroll or the recordkeeper.

Like the 401(k) deposit report, the nature of this data means this collection process can be really time-consuming. Plan administrators can spend a ton of time going back-and-forth with the auditor and digging up this information. Exactly how much time you’ll spend depends on the detail and organization of your employee records.


Step 3: Closing Audit Procedures

The Auditor’s goal: After the audit is complete, the auditor gives the plan administrator an audited financial statement to be submitted with Form 5500, as well as a report of the issues they uncovered. They’ll also conduct an interview to determine the plan’s internal controls and procedures.

The Plan Administrator’s goal: Answer any final questions from the auditor, fix any remaining mistakes, and then review, approve, and submit the audited financial statement along with the Form 5500.


401(k) Audit Deadlines

Your company’s financial statements must be completed and submitted with Form 5500 to the IRS 7 months after the end of your plan year (by July 31st).

Since the plan audit is submitted with Form 5500, you can file for an extension.


Getting an extension for your 401(k) audit

Mistakes happen. If the large plan audit/Form 5500 deadline is drawing near and it doesn’t seem like you’re going to have your audit completed in time, you can request a one-time 2 1/2 month extension by filing a Form 5558. That means your final due date is 9 ½ months after the end of your plan year, or October 15th.


Repercussions for missing a 401(k) audit deadline

The penalties for filing a late 401k plan audit can be quite costly. Depending on the size and nature of your 401(k) plan, penalty fees for late Form 5500 filings are around $25 for each day that’s passed after your deadline, up to $15,000. The DoL assesses a separate penalty that will cost you even more: $1,100 per day, with no limit.


Reducing penalties for missed deadlines

If your deadline has already passed and your Form 5500 is going to be filed late, you may be able to enter the DoL’s Delinquent Filer Voluntary Compliance Program (DFVCP). Think of the DFVCP as a forgiveness option: it’s a way to keep penalties from spiraling out of control. Late filers are given a chance to participate and voluntarily pay reduced fees before having to pay higher civil penalties. 

Under DFVCP, assessed late fees and penalties can be reduced. The maximum maximum penalty for a single late annual report is $750 for a small plan and $2,000 for a large plan. 

The DFVCP also includes a “per plan” cap, which is designed to encourage reporting compliance by plan administrators who have failed to file an annual report for a plan for multiple years. The "per plan" cap limits the penalty to $1,500 for a small plan and $4,000 for a large plan regardless of the number of late annual reports filed for the plan at the same time. While these fees may seem large, consider that they may be easier to handle than a $1,100 per day fine.

In order to qualify for the DFVCP, plan administrators:

  • Must comply with program regulations and 401(k) audit requirements, and
  • Must not have yet been notified in writing that their plan has failed to submit an annual report


3 Tips for a Stress-free 401(k) Audit

1. Stay on top of all the paperwork.

The Auditor will ask for a long list of documents. Some of the required items include plan documents, payroll records, and time-stamped communications related to the administration of your 401(k) plan.

Keep everything well-organized in one place, which will save you a LOT of time during the annual 401(k) audit season.


2. Partner with a Fiduciary 401(k) Advisor to administer your retirement plan. 

Sometimes, the easiest way to solve a problem is just to make it someone else’s. When you hire Prosperity as your Fiduciary 401(k) Advisor, we become legally responsible for administering your 401(k).

We can help you comply with regulatory requirements and minimize the risk of future audits revealing problems with your plan.

We’ll do all the heavy lifting when it comes to your 401(k) audit. That’s everything from assembling your Fiduciary documents to putting together the 401(k) deposit report. When you have a good Fiduciary 401(k) Advisor by your side, your only job is to locate any of the HR documents that we don’t have access to, like offer letters and HRIS screenshots.

Imagine that. The audit process, which could take months to complete, might only take you a couple of hours depending on how accessible your documents are.


3. Hire the right TPA to complete the audit.

Your TPA is the one who will prepare your audit for the IRS to review. Technically, any qualified independent accountant or CPA can do your 401(k) audit. But of course, not all 401(k) auditors are created equal. It’s essential to choose a company with the right experience—if the auditor misses something, and then the DoL catches it, it could be very costly.

  • When choosing a TPA, do your due diligence to ensure a smooth audit process by assessing the following:
  • What is the TPA’s auditing experience? Have they audited plans like yours?
  • Are 401(k) audits a side project, or are they a main focus of the firm?
  • What is their pricing structure? How much will it cost to audit your 401(k) plan?
  • Do they have any references?


We Can Help

It’s no secret that 401(k) audits are complex and time-consuming, but after reading this guide, you should be better-equipped for your first (next) 401(k) audit.

If you’re still feeling overwhelmed, we can help! As your 401(k) Fiduciary, we’ll relieve you of the legal responsibility for plan administration. We’ll take care of your 401(k) responsibilities including your annual audit, selecting investments, providing participant education, and much more. 

If you’re interested in learning more about our 401(k) Advisory services, please fill out the form below and we'll get back to you shortly. We look forward to hearing from you.

DISCLAIMER: Advisory Services offered through Prosperity Financial Group, Inc., an Independent Registered Investment Advisor. Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Prosperity Financial Group, Inc. and Fortune Financial Services, Inc. are separate entities.


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401(k), 401k audit, 401k audit deadlines, 401k plan checklist, tpa


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