Hitting the First Time Audit Requirement

Consider the following scenario: it’s October 10th, and you have just been notified by your third-party administrator that your retirement plan program has exceeded the maximum number of eligible participants to qualify for “small” plan status. Your program is now considered a “large” plan, and you have an annual audit due to the Department of Labor by October 15th.

This is something that no HR manager or CFO wants to hear. How did you get to this point? What has caused you to be under this requirement? What are the next steps to fulfill this requirement? And how can you plan ahead to ensure you are never caught in this position again?

When considering whether a retirement plan audit is necessary, the main factor is participant counts. For most plans, the magic number is 120. If a plan exceeds 120 eligible participants on the first day of the plan year, the plan is required to have a financial statement audit performed by an independent CPA firm.

Some of the items in the count are intuitive, but others are not so much. The count includes all currently eligible participants who are participating, those who are eligible but not participating, and any former employees who still have balances left in the plan.

Many organizations strive to know the standing of their counts at the end of the previous plan year (e.g. 12/31). While planning ahead is always admirable, these organizations run the risk of missing newly eligible participants on the first day of the next plan year (e.g. 1/1).

Because it is very common for newly eligible participants to be admitted to the plan on 1/1, the count from 12/31 to 1/1 can be drastically different; new participants can be forgotten until the employee and participant census is completed the following year. Despite great intentions, we know the rest of the story from the scenario above. Finalizing these participant counts on the last day of the plan year is simply too late.

Start-up plans are not exempt from these concerns; existing businesses that initiate a new employee retirement plan must also consider their counts. If the employee participant count is 100 or more on the date the plan document is signed and goes into effect, the plan is automatically under audit requirement and could be required to have an audit from the beginning.

Understanding these requirements and planning ahead can reduce some of the initial audit fees. The Department of Labor allows some leeway on audit deadlines if the first plan year is less than 7 months old. If this is the case, the plan has the option of delaying the audit until the next full year and submitting two completed audits at once. The auditor would then file both audits together with the Department of Labor in the subsequent 5500.

What if the count falls back below the minimum participant count for an audit? Once the participant number requirement has been met, an audit will be required for that year–and most likely the following year, too–even if the count falls back below the minimum. The Department of Labor will allow a plan to go from a large plan status to small plan once the participant count drops below 100 eligible participants. If the count is 99 or fewer on the first day of the plan year, the plan is considered a small plan for that year. The plan would continue to be a small plan until it crosses the 120 eligible threshold once more on the first day of a future plan year. As companies grow and add employees, this may not be possible, but for those that have steady employee populations, the audit requirement and the related challenges the audit provides may be avoided.

Plan for Success

An effective third-party administrator will work with you to maintain accurate counts at the correct level, monitor and notify you early about audit requirements, and help you make informed decisions that can eliminate or delay the need for a plan audit. Here are a few proactive steps that should be discussed with your third-party administrator:

1. Use a forward-looking census that allows for keeping track of participants who are not eligible, but will be within the next year.
2. Ensure that employees leaving the organization are aware of their ability to take distributions, and/or roll their account funds over to their new employers’ plan or an IRA. Make it part of the employee exit process to prompt taking action with their funds. An employee in the HR department should be responsible for following up with those employees when action is not taken.
3. Review the plan eligibility requirements. Does it make sense to have a short waiting period for eligibility? Do employee turnover rates affect this decision? Eligibility can be as soon as the day the employee begins employment or as far out as one year of service. Delaying eligibility as long as allowed will prevent those employees who may not be around long-term from being included in the overall participant count.
4. Review plan force-out provisions for participants no longer employed. For balances under $1,000, you can automatically cash out participants. And generally, participant balances between $1,000 and $5,000 can be rolled out to an automatic-rollover IRA.

By fully understanding and planning for precise counts, you can avoid the headache of surprise retirement plan audit requirements. What’s more, you can make informed decisions that will add value to your company and mitigate the long-term effects of retirement plan audits.