If you run a business that offers 401(k) plans to your employees, your plan should undergo an annual 401(k) audit. Essentially, this audit ensures your business is operating its plan correctly and doing right by its participants. For most businesses with over 100 eligible employees, the IRS requires that you complete an annual audit. With that said, it's essential to properly prepare for your 401(k) audit to keep it from becoming complex or time-consuming. Here is everything you need to know about 401(k) audits for small businesses and what to expect.
What is a 401(k) Audit?
A 401(k) audit is a process in which a qualified third-party firm reviews your company's 401(k) plan to ensure it is optimized for success, meets regulations, and follows the financial reporting guidelines provided by the Department of Labor and the IRS. In addition, the review will look at financial statements and the plan's Form 5500 to verify its accuracy.
How Do 401(k) Audits Apply to Small Businesses?
The 401(k) annual audit is recommended for all businesses, but becomes a requirement for larger businesses. If the total number of participants in the plan is more than 100, then your business may be required to complete an audit. What's important to note is that this number includes those who aren't participating, those who are eligible participants, as well as retired or terminated employees who have balances on their plans.
Audits Depend on the Size of a Business's 401(k) Plan
Even though independent audits depend on the size of a business's 401(k) plan, there are a few exceptions to the rule, such as if you have fluctuating or growing participants. For example, the 80-120 participant rule states that if you have between 80 and 120 participants, though you were not considered a "large" plan the year before, you do not require an audit. Instead, you will only need one once your participant count reaches 121 or more. If you are unsure if you need to complete a 401(k) audit, please review the IRS 401(k) Resource Guide, which outlines the requirements in more detail. For personalized 401(k) support, contact Horizon and our experts will help you understand the business compliance requirements in more detail.
What Do 401(k) Audits Encompass?
An accountant or third-party service provider may perform a 401(k) audit differently, though many will focus on the same fundamental points. Read on to learn more about what to expect for your company’s 401(k) audit.
Review of Plan Documents to Ensure Compliance
While it may seem obvious, the most important part of the process is reviewing the 401(k) plan documents you provide to verify compliance with rules set forth by the Department of Labor and the IRS.
Assessment of How Documents are Maintained
Next, the third party will assess how you maintain your electronic 401(k) records. This can include plan year information, files for participant records, and plan operation files. Being organized is key to keeping everything in line with your company’s records!
Ensuring the Accuracy of Information
The accuracy and completeness of the information on your 401(k) is equally important. An accountant or service provider will look at your 401(k) financial statements and Form 5500 Annual Return/Report of Employee Benefit Plan to ensure its accuracy.
Note Any Amendments Made During the Year
Lastly, they will look at any amendments you have made throughout the plan year, which is why it is crucial to keep a copy of your plan document with any changes you make, so you can ensure transactions are consistent with your plan records.
Confirm Rollovers and Distributions Were Paid Correctly
Distributions and rollovers paid into or out of a plan must be audited for accuracy and confirmation. If the rollover process was done incorrectly, it could be considered a distribution, making it subject to taxation. Keep detailed track of all transactions to ensure compliance and accuracy.
Interviews of Upper Management to Vet Concerns
Upon audit completion, the auditor will give the plan administrator an audited financial statement to submit with their Form 5500, alongside a report outlining any uncovered issues. During this process, they will interview upper management to vet concerns and determine the plans, internal procedures, and controls.
What are Some Common 401(k) Audit Errors?
An auditor may uncover administrative errors in your 401(k) plan post-evaluation, and it is essential to rectify those issues immediately to avoid problems with non-compliance. Let's look at a few of the most common 401(k) audit errors with which small businesses struggle.
Late Contributions Past the Deadline
If you do not deposit your participants’ contributions to their retirement plans in a timely fashion, you may be subject to fines, or your plan may be disqualified. Therefore, the best rule of thumb is to remit your contributions before the 15th of the following month after withholding. Of course, depending on your particular requirements or processes, you may work with a different timeline.
However, no matter what timeline you work with, make sure that it is clearly defined in your 401(k) document. The only remedy to this error is depositing late contributions. It's also essential to ensure that any deposit of late contributions is outlined on your Form 5500.
Understanding "Eligible Compensation"
Your business's 401(k) document determines employee deferrals and matching contributions using eligible compensation. If your document doesn't correctly define what that includes or excludes, such as commissions, overtime pay, or compensation, it could lead to incorrect matching contributions and deferrals.
This often happens when a company creates a new 401(k) document without including previous definitions after they switch over to another third-party administrator. How you fix this error will depend on whether your employees deferred a greater or lesser amount than the requirement. For example, excess earnings and deferrals cannot remain in an employee account. Instead, it is important to reallocate them based on detailed IRS guidelines.
Horizon is a Trusted Partner for Payroll & HR Compliance
If you are looking to offer employee benefits such as a 401(k) plan in your workplace, you have a lot to consider to meet IRS requirements. From setting up your documents to staying on top of annual compliance and paperwork from previous years, you must be well aware of every condition necessary when offering a benefit like this.
This is one of the reasons why so many small business owners turn to companies like us! Horizon Payroll has been a trusted partner for companies across the country since 1999.
Providing HR and Compliance Solutions Since 1999
Horizon has been providing payroll and HR solutions for over two decades, and we can help you design, administer, and maintain your 401(k) plans and more. In an ever-evolving financial landscape, it's easy for things to get confusing! We want to help you find your way through the tangle of 401(k) compliance and regulations with our full-service offerings.
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