Understanding 401(k) Audits: Answers to Frequently Asked Questions

Posted by Corie Stark on Oct 8, 2019

When a business reaches a certain number of eligible participants for their 401(k) plan, federal law requires an independent audit of that defined retirement plan. Larger companies are more accustomed to this annual requirement; however, owners and managers of smaller businesses may never have experienced a 401(k) audit or don't know nearly enough about it.


At what point is an employer required to complete a 401(k) audit? What is an "eligible participant" and why is it important? Who performs the audit and what documents do they need? We have the answers to these questions and more in our breakdown of 401(k) audits and how to determine if and when you should prepare for one.

What is a 401(k) Audit?

The Employee Retirement Income Security Act of 1974 (ERISA) first mandated the annual audit of a company’s 401(k) plan after carmaker Studebaker terminated their pension plan in 1963, leaving workers without retirement funds. Due to this, the primary objective of an audit is to ensure the retirement plan you offer complies with government regulations and specific requirements of your company's 401(k) plan. The audit can shine a light on any parts of the plan that are not in compliance and allow you to take corrective action, thereby minimizing risk to your employees and your company. To ensure unbiased results, 401(k) audits are conducted by independent public accountants or third-party vendors.

What Companies are Required to Complete a 401(k) Audit?

Companies with 401(k) plans only need to conduct an audit if they have 100 or more eligible participants in the plan. However, the "80-120 participant rule" allows you to hold off on 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 have one or more years to go before you are required to complete an audit.

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.

Who is an Eligible Participant?

In a qualified plan, employees are considered eligible participants if they meet these requirements:

  • They are a current employee eligible to contribute to the company's 401(k) plan, whether they are participating in the plan or not. The point at which an employee becomes eligible will be outlined in your plan document and may be defined by how long they've worked at your company.
  • They are a former employee with funds in the company's 401(k) plan.

Add those two groups together, and if you come up with 121 or more on the first day of the plan year, then you will be required to complete a plan audit.

What Does the Audit Cover?

While a service provider or an accountant may perform audits differently, there are general focal points they all emphasize:

  • Reviewing of 401(k) plan documents provided by you to verify your plan is compliant with IRS and DOL rules
  • Looking for any amendments made to the plan during the year
  • Determining the accuracy of information reported on Form 5500, Annual Return/Report of Employee Benefit Plan, and 401(k) financial statements
  • Assessing how your company maintains electronic 401(k) records
  • Examining employee contributions to ensure money was remitted in a timely way
  • Confirming distributions and rollovers were paid out properly
  • Sampling specific participants’ transactions to further ensure compliance
  • Interviewing upper management to vet any concerns

This extensive process can last anywhere from three to four months, depending on the quality and access to your data. Average sized businesses can see costs of $10,000 to $12,000 with Fortune 500 companies seeing much higher bills.

How Do You Prepare for an Audit?

Keeping track of plan-related documents throughout the year is one of the simplest ways to prepare for an audit. In addition to your plan document, be sure to have your most recent Form 5500, W-2s, loan requests, loan repayments, distributions, and other information related to your employees and their 401(k) activity.

For smaller companies who are experiencing steady growth, it’s important to monitor how many eligible participants you have in your plan. Planning will prevent any surprises and give you a head start in tracking the necessary documents leading up to your first audit.

Regardless of the size of your plan, be sure to lean on your 401(k) provider for assistance in gathering the necessary information for your auditor. They can also work directly with your auditor to reduce the amount of time you have to be involved in the project. It’s important to thoroughly research this service provider beforehand to ensure a seamless audit, according to the Chief Executive Officer of ERISA Consultants, Richard Phillips.

“Vet your service provider. Make sure you’ve done your due diligence so that you know you have good support from them and know they can provide the documents and records that are needed to make it a smooth audit process,” Phillips states.

What Comes After the Audit?

Once your independent 401(k) audit is completed, you'll attach the report to Form 5500. All businesses with 401(k) plans must file Form 5500, Annual Return/Report of Employee Benefit Plan. This annual report, registered with the Department of Labor (DOL) and the Internal Revenue Service (IRS), provides information on your 401(k) or other benefit plan.

Information collected includes the type of plan, the plan sponsor's information, plan administrator's information if different, and number of participants. It is the source for determining whether your plan is considered small or large and whether you've crossed the eligible participant threshold and will be required to complete an annual audit going forward.

Form 5500 comes with a dizzying 28 pages of instructions. Luckily your 401(k) provider, along with your independent auditor, will take care of the heavy lifting to fulfill this annual requirement.

For more information on 401(k) audits and how they can work to enhance the plan you have, read What CFOs Should Know About Retirement Plan Audits from cfo.com.


Topics: Employer Basics, Human Capital Management

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