As a finance and investment expert, I often encounter questions about retirement plan audits. Many plan administrators and sponsors struggle with understanding when an audit is required, what it entails, and how to prepare for it. In this guide, I break down the audit requirements for retirement plans in the U.S., including key regulations, mathematical calculations for participant thresholds, and best practices for compliance.
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Understanding Retirement Plan Audits
A retirement plan audit is an independent examination of a plan’s financial statements and operations to ensure compliance with the Employee Retirement Income Security Act (ERISA) and other federal regulations. The primary purpose is to protect plan participants by verifying that funds are managed correctly.
When Is an Audit Required?
Not all retirement plans require an audit. The need depends on the number of eligible participants. Under ERISA, a plan must undergo an audit if it has 100 or more participants at the beginning of the plan year. However, there’s a crucial exception—the 80-120 Participant Rule.
The 80-120 Participant Rule
If a plan has between 80 and 120 participants at the start of the year, the plan sponsor can elect to file the same form (Form 5500) as the previous year. This means:
- If the plan filed as a small plan (fewer than 100 participants) last year, it can continue doing so until it exceeds 120 participants.
- If it filed as a large plan (100+ participants) last year, it must continue filing as a large plan unless the participant count drops below 80.
Example Calculation:
Suppose a plan had 95 participants last year and filed as a small plan. This year, it has 105 participants. Since it falls within the 80-120 range, the sponsor can still file as a small plan. However, if the count reaches 121, an audit becomes mandatory.
Calculating Participant Counts
The participant count includes:
- Active employees contributing to the plan.
- Retired or separated employees with account balances.
- Deceased participants with beneficiaries entitled to benefits.
The formula for determining the participant count is:
\text{Participants} = \text{Active Employees} + \text{Separated with Balances} + \text{Beneficiaries}Example:
- 75 active employees
- 20 former employees with balances
- 5 beneficiaries
Total participants = 75 + 20 + 5 = 100 → Audit required.
Key Audit Requirements Under ERISA
ERISA mandates that large retirement plans submit audited financial statements with Form 5500. The audit must be conducted by an independent qualified public accountant (IQPA).
What the Audit Covers
- Plan Financial Statements – Verification of assets, liabilities, and net assets available for benefits.
- Internal Controls – Assessment of procedures for contributions, distributions, and recordkeeping.
- Compliance Testing – Review of nondiscrimination, coverage, and top-heavy tests.
- Fiduciary Oversight – Evaluation of whether plan trustees acted in participants’ best interests.
Common Audit Findings and Pitfalls
Many plans fail audits due to:
- Late or incorrect employee deferrals.
- Missing participant census data.
- Failure to perform required compliance tests.
Example of a Compliance Test:
The Actual Deferral Percentage (ADP) Test ensures that highly compensated employees (HCEs) do not disproportionately benefit. The formula is:
Where:
- \text{ADP}_{\text{HCE}} = Average deferral percentage for HCEs.
- \text{ADP}_{\text{NHCE}} = Average deferral percentage for non-HCEs.
Calculation Example:
If non-HCEs defer 4% on average, HCEs cannot defer more than 4\% \times 1.25 = 5\%.
Comparing Small vs. Large Plan Requirements
| Requirement | Small Plan (<100 participants) | Large Plan (100+ participants) |
|---|---|---|
| Form 5500 Filing | Simplified (Schedule I) | Full (Schedule H) |
| Audit Needed? | No | Yes |
| IQPA Requirement | Not required | Required |
| Compliance Testing | Still required | More stringent |
Steps to Prepare for a Retirement Plan Audit
- Review Plan Documents – Ensure the plan’s terms match operations.
- Reconcile Financial Records – Confirm contributions match payroll records.
- Test Compliance – Run ADP/ACP and top-heavy tests in advance.
- Engage an Auditor Early – Avoid last-minute delays.
Cost Considerations
Audit fees vary based on plan size and complexity. A typical 401(k) audit costs between $5,000 and $15,000. Factors affecting cost include:
- Number of participants.
- Plan investments (self-directed accounts increase complexity).
- Quality of internal recordkeeping.
Final Thoughts
Navigating retirement plan audits requires careful planning. By understanding participant thresholds, compliance tests, and audit procedures, plan sponsors can avoid penalties and ensure smooth operations. If you’re approaching the 100-participant mark, start preparing early—audits are not just a regulatory burden but a safeguard for employees’ futures.
