Preparing for a First-Time 401k Plan Audit

Preparing for a First-Time 401k Plan Audit

For retirement plan administrators preparing for a first-time audit, much of the process can seem overwhelming: gathering and organizing data, evaluating and communicating with service providers, and adhering to strict and time-sensitive compliance obligations.

To facilitate an efficient independent audit process and prevent future compliance inquiries from the IRS and Department of Labor (DOL), consider these areas as your organization prepares for its initial 401k audit.

Audit Requirements

An important place to start is understanding what exactly your audit requirements are based on your Plan. If your Plan has never been subject to an external audit but now supports more than 120 eligible participants, it is considered a “large plan” and thus, an annual independent audit of Plan financial statements is required under the Employee Retirement Income Security Act of 1974 (ERISA).

NOTE: While first-time audits require a 120-participant threshold, subsequent audits will trigger when Plan participants reach a minimum of 100. Additionally, according to the 80-120 rule, Plans with between 80 and 120 participants at the start of a Plan year are eligible to file Form 5500 under the same category (small or large) as the previous filing year, meaning if your Plan had 99 participants at the time of your last audit, but has since increased to 110, you may still file Form 5500 and its supplementary requirements as a “small plan” (and therefore, no audit would be required for the current plan year).

Plan Document Specifics

It sounds almost elementary to suggest that a Plan Administrator might not fully understand the specifics of its Plan Document, however, deficiencies related to Plan specifications within the Plan Document account for the vast majority of deficiencies and findings during an initial audit of the Plan.

Perhaps most importantly, Plan Administrators must understand the definition of compensation as outlined within the Plan Document. This definition dictates what compensation should be deferred upon and, in many cases, includes wages such as bonuses, commission and other fringe benefits, which may be defined as eligible compensation within the Plan Document but not properly deferred upon within the Plan Sponsor’s payroll process. This operational failure can lead to costly and time-consuming corrective actions, not to mention initiate a red flag with the Department of Labor.

Ultimately, Plan Administrators preparing for a first-time audit should ensure they maintain a comprehensive understanding of their Plan Document so as to avoid having to make corrective contributions on improperly excluded compensation.

Internal Controls

In preparation for a first-time audit, it’s also critical to examine the organization’s internal controls and identify deficiencies that may lead to significant corrective actions or ERISA violations. For example, payroll processes should be well-documented and include procedures for handling adjustments to employee contributions. When Plan participants make elective adjustments to their deferred compensation figures, it’s essential that those changes are processed through payroll in a timely manner to prevent discrepancies. These timing delays in participant elections are another area that can cause audit deficiencies and could result in Plan Sponsors having to make costly corrective contributions to participants’ accounts. Participant complaints are also common audit triggers for the DOL, and thus, administrators should be careful to adhere to proper internal controls to avoid inflaming any unnecessary grievances.

Service Providers

As the Plan Administrator, your organization retains the fundamental responsibility for the compliance of the Plan – which is why you’re the one facing a first-time audit. But because you rely on various service providers to support the Plan’s goals, it’s important to understand each provider’s responsibilities and properly manage these relationships to prevent the Plan from triggering audit deficiencies. As an example, record-keepers are responsible for tracking contributions and investments on a participant level, and thus, will need to provide the Plan Administrator with timely and thorough reports in advance of an independent audit. Administrators should ensure there’s clarity between parties regarding these reporting requirements and plan in advance to ensure a delay in data collection doesn’t hamper the audit process.

Early Preparations

Speaking of delays, perhaps the best advice for retirement Plan Administrators preparing for a first-time audit is to prepare early. Because a first-time audit could mean that the auditors will be testing transactions back several years or to the inception of the Plan, there is significant time involved in gathering that data, especially if there has been a change in service providers during that time. Independent audit reports must be completed seven months after the Plan year concludes (or 10.5 months, if extended), so there is limited flexibility for administrators in collecting and providing necessary data and financials to the auditor.

In some cases, the independent auditor can begin with preliminary work before the official audit commences, giving the administrator additional time to clear up discrepancies or fix errors before the start of the audit. Starting the preparations early can lead to a smoother, more efficient audit process and, perhaps, prevent audit investigations from the IRS or DOL down the line.

To speak with an audit professional regarding preparations for your organization’s first-time audit, please contact the team at MFA.

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