What Is a 401(k) Audit?
A 401(k) audit is an examination of a retirement plan to verify that it meets the requirements of the Employee Retirement Income Security Act (ERISA) and any related Internal Revenue Service (IRS) and US Department of Labor (DOL) regulations.
It helps ensure that contributions, distributions, and investments meet legal standards. A 401(k) audit can also reveal whether the plan is being administered properly and may be capable of detecting any misappropriation of plan funds.
It is done by a third-party accountant or firm experienced in auditing retirement plans. The auditor will evaluate various documents, including Form 5500, financial statements, and participant records.
Auditors may also interview plan administrators and participants to ensure all information is accurate and up-to-date.
When Does a 401(k) Plan Need Auditing?
Employers with 401(k) plans may need to perform an audit depending on the number of participants in their plan. Generally, an audit must be accomplished if a plan has more than 100 participants at the beginning of the plan year.
401(k) plan audits must be completed within 7 months after the plan year ends. Suppose your company's 401(k) plan follows the calendar year. The audit for the previous year must be finished by July 31 of the current year.
You can also apply for an extension which gives your company an additional two and a half months to comply if approved. Following the previous example, the extension will be until October 15.
However, other factors, such as service provider changes or 401(k) plan document amendments, can also necessitate an audit.
401(k) Audit Checklist for Employers
To facilitate a 401(k) plan audit, you must provide auditors with basic information and documentation. Consider the following:
Financial Reporting and Information
Documents and information regarding financial reporting are usually provided by your plan's third-party administrator or asset custodian.
It can include year-end reports, account statements, contribution activity reports, investment activity reports, and participant loan activity. The plan administrator may also compare financial statements to a draft Form 5500.
You will also need to provide information regarding the plan's financial position at year-end and any transactions during the fiscal year.
When a bank or insurance company certifies that the year-end reports are complete and accurate, the custodian or trustee may grant a reduction in the scope of audit procedures in the investments area.
Internal Controls for 401(k) Plans
Internal controls are policies and procedures that help protect plan assets from misappropriation or abuse. Employers must demonstrate sufficient internal controls to ensure compliance with ERISA requirements.
Auditors may review any changes to the plan document, employee handbook, and Form 5500 for the preceding year. They may also review how plan assets are invested, how employee contributions are calculated, and participant eligibility requirements.
Employers may also need to provide proof that all participants in the plan were notified of any changes made during the year.
Participant Account Balances in the 401(k) Plan
You must demonstrate that all participant account balances are accurate and up-to-date. Auditors will request information regarding contributions, distributions, loans, and transfers for each participant during the fiscal year.
Auditors may also compare this information against payroll records to verify that all employees received their correct contribution amounts.
Additionally, any automatic enrollment or re-enrollment activity may be reviewed, along with the actual deferral rates of participants who elected to participate.
Investment Information for 401(k) Plan Participants
Auditors may also assess the performance of 401(k) plan investments. They will review investment data, reports, and documents related to any changes in the plan's lineup of investments made during the year.
Auditors may also compare the performance of these investments against benchmarks and other relevant indices to ensure that they are performing in line with the plan's objectives.
Tracking of 401(k) Contributions, Rollovers, and Forfeitures
Auditors will review all participant contributions, rollovers, and forfeitures in the plan during the fiscal year. They will review records to ensure contributions are promptly recorded and credited to the correct accounts.
To verify the accuracy, contributions will be compared to payroll records, like W-2 and W-3. Employer contributions may be recalculated to ensure plan design and provisions compliance.
Instances of late remittances will be recorded, and corrections will be suggested for any lost earnings. Additionally, they may examine records of rollovers received from qualified plans. The plan documents will be reviewed to confirm that rollovers are allowed.
Forfeitures must also be tracked and accounted for in accordance with plan terms. Forfeiture balances are recommended to be applied to reduce the contributions as IRS has increased scrutiny in this area.
Recording of Benefits Payable and Expenses for the 401(k) Plan
Auditors will review records of benefits payable and expenses incurred by the plan during the year. It may include any fees paid to service providers, payments made to participants or former employees, and expenses related to plan administration.
The vesting schedule is a crucial aspect of the audit. Proper vesting percentages must be pursued and tracked to ensure compliance. Auditors may also examine records of investment expenses, such as custodial fees and advisor charges.
Documentation for Compliance Testing of the 401(k) Plan
Compliance testing is a requirement for all 401(k) plans. It involves comparing the actual plan operations against the requirements of ERISA and other laws.
Auditors will review documents related to compliance testing, such as Form 5500, Summary Annual Reports (SARs), participant notices, and any corrective action taken in response to any findings.
They may also review the plan document to determine if it contains all the requirements and any amendments made during the year.
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Common Issues Found in 401(k) Audits
These include plan eligibility provisions and actual practice mismatch, the discrepancy between compensation definition and actual payroll procedures, and late remittance of participant salary deferrals.
Failure to Review Plan Eligibility Provisions and Compare to Actual Practice
Plan sponsors are responsible for ensuring that specific plan eligibility provisions match actual practice.
Employers should review the plan document and confirm if any employee may have been omitted from participating in the 401(k) plan due to incorrect classification as an independent contractor or another employment status.
The reverse is also possible, where an ineligible employee is included in the 401(k) plan. Some plans have age requirements for participation, while others have a specified waiting period before an employee is eligible.
Failure to Review Plan's Compensation Definition and Compare to Payroll Actual Procedures
The plan document should define which salaries and wages are considered for the 401(k) limit. This definition of compensation may not match what is included in payroll procedures.
For example, some plans exclude bonuses from their definition of compensation, but the payroll system may include bonuses when calculating retirement contributions. This mismatch needs to be identified and corrected.
It highlights the importance of smooth payroll integration with your third-party service provider to ensure accurate contributions.
Late Deposit of Participant Deferrals in 401(k) Plan
Employers are also responsible for ensuring that salary deferrals and employer matching funds are remitted promptly. Contributions should be deposited within the plan's timeframe or no later than one month after the end of the tax year.
Plan sponsors may be liable for penalties and losses incurred due to missed investment opportunities if contributions are not remitted on time.
Additionally, employers must ensure that their plan document does not allow for excess deferrals, which would violate ERISA.
Best Practices For Preparing Your 401(k) Audit
To ensure a smooth and potentially successful 401(k) audit, consider the following:
Understand the Statement on Auditing Standards 136 (SAS 136)
SAS 136 is an auditing standard set by the American Institute of Certified Public Accountants (AICPA) that organizations must meet to have their 401(k) plan audits accepted by the IRS.
It details guidelines for auditing pension plans, including the procedures to be followed by an auditor and standards for plan documentation. Familiarizing yourself with these guidelines can prepare you for the audit.
Assign Responsibility for 401(k) Plan Audit to a Plan Sponsor Representative
The plan sponsor should appoint someone to be responsible for managing the audit process. This individual should thoroughly understand the 401(k) plan and associated documentation.
The representative provides all necessary audit requests. They should also coordinate with other parties involved in the audit, such as third-party administrators or record keepers.
Set up a Calendar of Important Dates for 401(k) Plan Audit
It is important to create a timeline for all aspects of the audit process. It includes major milestones, such as when the auditor receives data from record keepers and when reports will be submitted to the plan sponsor and IRS.
The timeline should also include deadlines for responding to requests or gathering documents. Having an organized timeline helps ensure that each audit step is completed on time.
Provide Minutes From Meetings of the Plan Oversight Committee
The plan oversight committee is responsible for providing fiduciary oversight to the 401(k) plan. The minutes from their meetings must be made available to the auditor to help identify any potential issues or discrepancies in the management of the plan.
These documents should include information on how decisions were made, what changes were approved, and which investments were discussed.
Reconcile Census Report & Payroll Summary Report
The census and payroll summary reports provide the auditor with a comprehensive view of plan activity. This data should be reconciled and verified to ensure accuracy.
It should also include information on employee contributions, employer contributions, and any participant loans or withdrawals.
These documents must reflect accurate participant eligibility information to ensure the appropriate contributions were made to the plan.
Keep a Summary List of Key Plan Amendments and Changes
The auditor will need to review any changes made to the plan since its inception.
To make this process easier, it is helpful to keep a summary list of all significant amendments and changes that were made. It should include dates when the amendments took effect and a description of the change.
This list makes it easier for the auditor to review which changes have been made and when they happened.
Have All Requested Documents and Information Ready
The auditor will need to review a wide range of documents and information related to the sustainable 401(k) plan. All of these should be gathered in advance and readily available when the auditor requests.
These include plan documents, amendments, participant records, third-party administrator reports, IRS forms, financial statements, and other supporting materials. Your selected representative or point person should be responsible for this.
Provide a List of Key Subsequent Events to the Auditor
Events such as mergers, acquisitions, and changes to plan documents and processes should be reported to the auditor.
The auditor will need this information to ensure that all events are properly reflected in their audit report and that no issues were overlooked. A comprehensive list of key subsequent events can help expedite this process.
Ensure Timely Remittance of Participant Contributions to the 401(k) Plan
It is important that participant contributions are timely remitted to the 401(k) plan. Delays can result in costly penalties or fines and should be avoided at all costs.
Your selected representative should confirm that all employee contributions have been properly collected, documented, and deposited with the 401(k) plan within the time frame specified by the DOL.
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The Bottom Line
A 401(k) audit is an important part of managing a retirement plan for the benefit of both employers and employees. It is generally made when a 401(k) plan has 100 or more participants at the start of a plan year.
It can also be triggered by certain events, such as an amendment to the plan, a transfer of assets, or adding a new service provider. A 401(k) audit is performed by a third-party firm, such as an accounting or auditing company, to ensure the plan complies with regulations.
The audit includes reviewing the plan's documents and procedures, internal controls, participant contributions and investments, distributions, rollovers, forfeitures, benefits payables and expenses, and compliance testing.
Common errors companies commit involve the incongruence of eligibility provisions and actual practice, a mismatch between compensation definition and payroll procedures, and delayed salary deferral remittances.
Best practices for smooth and successful 401(k) audits exist. Companies and plan sponsors must understand SAS 136, assign an audit point person, define key dates, and provide oversight committee meeting minutes are some examples.
Consult an accountant or financial advisor for guidance and to ensure the ongoing compliance of your 401(k) plan. A successful audit can protect employers from potential liabilities and give employees greater assurance that their retirement savings are secure.
401(k) Audit Checklist for Employers FAQs
What is a 401(k) audit?
A 401(k) audit is an independent third-party review of a company's retirement plan operations and internal controls. The audit process will identify potential violations of the Employee Retirement Income Security Act (ERISA) or other applicable regulations, as well as any areas of noncompliance with the plan document. A successful audit helps employers ensure that their 401(k) plans comply with the law and are correctly administered.
How often should employers conduct 401(k) audits?
There is no set frequency for conducting 401(k) audits, as every plan has different needs. Generally, employers should conduct an audit if the 401(k) plan has more than 100 participants at the start of the plan year. It can also be made on an ad-hoc basis if any major changes have been made to the plan.
What are the consequences of non-compliance with 401(k) regulations?
Failure to comply with 401(k) regulations can have serious consequences. Depending on the nature of the violation, employers could be fined or penalized by the Department of Labor (DOL). In extreme cases, employers may be subject to criminal penalties such as hefty fines and even imprisonment.
What are some common issues found in 401(k) audits?
Delayed remittance of participant contribution, plan eligibility provision and actual practice mismatch, and incongruent compensation definition and payroll integration are common issues in 401(k) audits.
How can employers avoid 401(k) compliance issues?
Compliance issues can be avoided by understanding federal laws and guidelines, familiarizing oneself with auditing standards, preparing accurate financial information, depositing participant contributions on time, carefully following 401(k) plan provisions, and documenting key events and amendments in the plan.
