As your business grows, there may come a time when you need to have an external 401(k) audit. What should you know about the process before you hit that key number of 120 eligible employees? We are experienced when it comes to 401(k) audits. Here’s what we’ve seen at Chortek, and what you should think about before you need one.

Why Would I Need a 401(k) Audit?

Your business will spark its first 401(k) audit when you have 120 eligible employees at your company. This doesn’t mean that 120 employees would have to participate in your 401(k) plan, but they would be eligible to participate. After that, if you have over 100 eligible employees, your company is considered to have a large plan. A large plan requires an audit. Likewise, under the “80-120 participant rule,” if you happen to be over 100 employees, but filed as a “small plan” in the previous year, you can do that in the current year as long as you have under 120 eligible employees.

We’ll be honest – nobody comes to us asking for a 401(k) audit. The reason you’d get one is to make sure you’re compliant, so you don’t suffer penalties from the IRS. So, once you hit that 120 number, you’re going to need one, and in all following years where you have more than 100 eligible employees.

What are the Most Common Problems We See on 401(k) Audits?

The biggest thing we see at Chortek when working on 401(k) audits for our clients is that people either over-rely or misunderstand what it is their recordkeeper does. Make sure you have an understanding of what your recordkeeper collects and what payroll records, because ultimately, your company is responsible for keeping track of everything, and will pay the fine related to any missing documentation. Download our checklist for the list of documents you will need to be ready before the process even starts.

We also see frequent miscommunication or disconnection between the payroll provider and the recordkeeper. For example, if an employee increases their contribution by 2%, how is payroll informed about that? How does the system work for changes? When there is a communication breakdown, it’s more common for a company to fail to remit contributions in a timely manner. We can help provide insight and advice on what we’ve seen successful clients do in the past for these processes as part of our work with you.

What Should You Do If You’re Close to Needing a 401(k) Audit?

First, if you’re close to needing a 401(k) audit, meaning you are close to having 120 eligible employees, your first priority would be in seeing if you can delay the audit another year or so. Go through your trust report to look for people whose balance is below the cash out level. If they are either no longer employed by you or have retired, they can automatically get out of the plan. Keep their number down to push the audit off longer.

Second, make sure you are determining eligibility correctly. Are people in your plan able to participate on a timely basis? If not, you owe them money from the time they were supposed to be enrolled in the plan versus the time they were actually enrolled. If you’re doing some piece of eligibility wrong, like not responding quickly to manual pieces of auto enrollment, you could owe your employees their contribution, plus the match, plus lost earnings. Your company is on the hook for any mistakes in determining eligibility.

Before you ever need a 401(k) audit, you should make sure what your plan documentation says matches up with what you’re actually doing, and if not, work to amend the plan document. You can write almost any amendment and any provision to make your plan document describe the way your plan works, but you have to have it in place well before your audit.

What Types of 401(k) Audits Are There?

There are two different types of 401(k) audits – the limited scope and the full scope.

A limited scope audit saves time and is more affordable, because your accounting firm isn’t auditing investments or investment activity. It is the most common type of audit, and is essentially about compliance – Regardless of intentions, are you doing what your plan document says? You should be treating your document as the governing body of your 401(k) plan. To find out if you are eligible for a limited scope plan, you need to ask the custodian of your assets to issue a certification on the assets (generally your custodian is an entity like a bank or a life insurance company). If the certification goes through, we can do a limited scope audit for you.

A full scope audit includes lots of additional procedures, including an audit on the valuation of the investments themselves. If we were to conduct a full scope audit for your company, we would need to report on the dividends received, daily valuations, and many other figures. Because it is more time- and labor-intensive, you want to find out if you can get a limited scope audit first.

What Else Can We Do For You?

When auditing your 401(k) plan, Chortek can also advise on provisions to change in your plan to make them a better match for your business. We can look at the eligibility requirements versus your goal for the plan, and see if those requirements are helping you achieve your goal. Based on employee retention, the nature of your business, and the characteristics and practices of the people involved with the plan’s operations, we can advise you on what provisions might be the best fit for your company.

We can also provide consulting services before you hit 120 eligible employees to help you make sure everything is in order when the day comes that you need an audit.

Outside of 401(k) audits, we are a firm that can provide a wide array of services that can help you achieve success for the life of your business – outsourced accounting, state and local tax services, and managed IT services, to name a few. Managing your business is stressful enough, without having to worry about the behind-the-scenes processes to keep it running smoothly. Chortek can manage some of that burden for you.

Want to learn more about what we can do for your business? Contact us today!

Written by Julie Schroeder, CPA, Partner
Posted in Audit