When is a 401(k) Plan Audit Required?

By Jenny VanderBoon, CPA, MBA, Manager; Steve Triezenberg, CPA, MBA, Partner; Nicole Wojciakowski, Manager; Jennifer Onderko, CPA, Director of Accounting & Auditing Quality Control, Hungerford Employee Benefit Audit Team

The establishment of a 401(k) plan is a major milestone for any small business. However, as the plan’s participant base expands, the necessity of an independent audit is often an unexpected regulatory hurdle.

The confusing part? It’s not necessarily based on the number of employees.

Don’t worry; we’re here to help you stay compliant and ensure a seamless audit experience.

An employee benefit plan audit is required when a company has 100 or more participants. But how is a “participant” defined? How do mergers and acquisitions affect participant counts? And what dates should you keep in mind to stay compliant?

Who Counts as a Participant?

A participant is any employee who has an account balance with your company’s plan — 401(k), 403(b), employee stock ownership plan (ESOP) — regardless of employment status.

This includes:

• Current employees contributing or who have contributed
• Current employees who have rolled their account balance over from a former employer
• Former employees who still have money in the plan

Eligible employees who have not yet contributed no longer count as a participant for the audit requirement, only those who have an account balance in the plan.

For organizations hovering around the 100-participant mark, the “80-120” rule provides a little bit of flexibility.

Understanding the 80-120 Participant Rule

First, let’s define what makes a plan small or large.

• Small plan: Fewer than 100 participants
• Large plan: 100 or more participants

An audit is necessary when your Plan files Form 5500 as a large plan. However, there is some flexibility for organizations slightly below or above the 100-participant mark.

The 80-120 participant rule gives an exemption to plans that have between 80 and 120 participants, allowing them to file in the same category (small or large plan) based on how they filed last year.

For example, if Plan A had 85 participants last year and filed as a small plan, then they can continue to file as a small plan until they hit 121.

On the other hand, if Plan B had 110 participants and filed as a large plan last year, then they must file as a large plan until they drop below 100 participants.

The main takeaway? Keep an eye on your participant count to avoid fines that come with filing incorrectly.

Triggering Events and Plan Growth

Let’s say your organization merges with another company or buys a smaller company: How does that affect your audit requirements?

If Company A has 60 participants, and Company B has 65 participants, both are below the audit requirement threshold. But if they merge, they will have 125 participants and may be subject to an audit if their plans combine.

Of course, hiring booms and large turnovers can affect audit requirements as well.

Additionally, changes made to the plan, such as new employer contributions, allowing loans or hardship withdrawals, or new payroll systems, will likely require additional testing by the auditors.

Be sure to track any plan changes to save yourself from headaches down the road and to help your auditors perform their job more efficiently.

The Role of Form 5500 and the Audit

Form 5500 is a tax form an organization files for its plan, similar to how an individual files Form 1040 every year to report their income. If an audit is required, it is attached to Form 5500, and the auditor is required to review a substantially complete Form 5500 for consistency with the audited financial statements.

However, there’s no tax due with a Form 5500; it’s simply a required, informational form.

All organizations with 100 or more participants must file a Form 5500, while those with fewer than 100 participants must file a 5500-SF.

Filing this form is vitally important, as failure to do so (or filing it incorrectly) can result in daily late fees and fines from the IRS and Department of Labor.

It is common to incorrectly count participants. This mistake is understandable, as the rule that defines who is a participant recently changed.

Remember, participants are only those who have money in their account, including former employees who have not yet taken a distribution. Previously, any plan with at least 100 eligible participants required an audit, even if those eligible were not contributing to the plan.

Since 2023, that is no longer the case.

Now that you understand the basics, you’ll need to keep track of certain dates to avoid late fees.

Timing and Deadlines

The original filing deadline is seven months after the plan’s year end date.

For example, if your plan has a Dec. 31 year end, then your Form 5500 deadline is July 31 of the following year. However, an extension is available.

If you need an extension, you can request a 2.5-month extension that will change your deadline to Oct. 15. Extensions must be requested before the original July 31 deadline.

Not only can your organization incur fees for missing deadlines, but your plan may ultimately risk disqualification.

Choosing the Right Auditor

Once you determine you need an audit, selecting an experienced auditor is the next compliance safeguard.

The easiest way to do this is to find a firm that is a member of the AICPA Employee Benefit Plan Audit Quality Center, which means the firm has gone through proper training and adheres to rigorous requirements. In other words, they perform high-quality audits you can trust.

When selecting an auditor, prioritizing a firm that specializes in this niche field is essential. Employee benefit plan audits are distinct from standard financial audits, requiring specialized training and technical nuances. Firms that only perform a few of these engagements annually may lack the expertise necessary to navigate complex regulatory requirements.

Get Prepared for Your Audit

We assist organizations in properly assessing the timing of a potential audit requirement. If the audit is imminent, timely initiation of the process is crucial. This would include proactively conducting a planning meeting and providing plan documents to the auditor. Starting this process early directly contributes to a simplified, cost-effective and streamlined audit experience.

If you’ve never done an audit before or are looking to change auditors, let’s talk. We’ve helped
hundreds of clients navigate the process with ease.