Lessons Learned from 401(k) Audits

Plans with fewer than 100 participants can learn from the big boys

By Steven E. Parmelee, Member, CSCPA Employee Benefit Plans Committee

The great majority of 401(k) plans in Connecticut have less than 100 participants and are not required to have an annual audit. But wouldn’t it be useful to know what kinds of problems are often found at the large end and how to correct them?

In the under-100-participant market, an audit is often triggered by a participant complaint or even by a vendor who is required to report certain discrepancies, so it’s wise to have your house in order as much as possible before the Department of Labor (DOL) contacts you. Aside from asking about the specific complaint, the DOL usually has additional questions that are time-consuming to answer or prove (getting copies of cancelled checks, for example). Below are some of the most common problems which have been identified by both CPA and other fiduciary audits.

Timing of contributions is a top priority of the DOL Employee Benefits Security Administration (EBSA), and on a practical basis, it’s really a matter of establishing a timeframe that the DOL will accept. The common misconception is that you can wait until the 15th business day of the following month in order to submit contributions, but the true standard is that these monies should be submitted as soon as they can be segregated from the employer’s general assets. Recent experience shows that the DOL is not being very flexible on this and employers should make every effort to at least meet the seven-day safe harbor rule.

A typical finding is that contributions from weekly or bi-weekly payrolls are only submitted to the trust once a month. Aside from the fact that participants are not getting an accurate investment return, they are also more savvy and informed than ever and can easily become upset if they miss a positive market move after the recent negative performance. For those who chose a safe (guaranteed) investment, there is even more sensitivity. We know of a participant who urged the plan sponsor to submit contributions electronically after he figured out that a check was being mailed and the money not posted for several days after the contribution. Imagine if the company was outside of the guidelines!

The DOL has beefed up its staff and is waiting for phone calls on this subject, and they will trigger an audit.

Your client should also be especially careful at the end of the year. I recently saw a company submit the last contribution run for the year, which left off one of the partners. When the error was discovered, the missing amount was included in the next payroll and noted accordingly. In the meantime, the insurance company vendor reported this on the Form 5500 as “contributions not received on a timely basis,” and this resulted in a DOL audit.

Finally, you should also know that auditors may look back several years to make sure that there is a consistent pattern that falls within the guidelines. It’s not how fast you remit the monies (within the guidelines), but whether or not there is consistency.

A second area of concern is when the plan is not administered in accordance with the plan document. For example, compensation often includes bonuses or other earnings outside of base salary, yet participant contributions are either submitted – or omitted – in violation of the plan document.

Another example is when the plan specifies that matching contributions are made on an annual basis, but the client submits the match for each pay period and does not true it up at the end of the year. You should encourage your clients to read the plan document and compare it to the actual administration of the plan.

Other potential plan document/administration issues include allowing some people into the plan before they are eligible, not informing some employees that they are eligible, and allowing part-time employees into the plan. Each of these can lead to disqualification if there is an intentional pattern of favoring certain employees over others.

In the current economy, the increase in the number of participant loans has also produced an increase in incorrect documentation. Typical areas of concern the IRS identified include: missing (or improper) documentation, failure to adhere to the amortization schedule, excess loan amounts, and, increasingly, making more loans than the plan document allows.

Using incorrect data in ADP/ACP testing is another area of concern. The smaller the plan, the more likely that the information submitted to the vendor is incomplete or incorrect. I have seen several cases where organizations thought they had passed the tests with flying colors only to find out otherwise, because the plan had reported the contribution information on all participants rather than all who are eligible to participate. Since those who are eligible but not participating count as a zero, the actual results of the test were dramatically different. Many small plans only recite back the information they think they are asked for and, since they don’t understand the nuances, do so incorrectly.

Has the plan been updated for recent legislation (i.e. EGTRRA, GUST, and PPA 2006)? This year most plans will be entirely restated, which will give plan sponsors a new starting point. But if there is an audit, the DOL will be looking for consistent adherence to the latest legislation. Importantly, these updates must also be applied to the Summary Plan Descriptions (SPDs); it’s not uncommon for the plan to be updated but not the SPDs.

The current economic climate, coupled with a grouchy participant population and increased DOL staffing, means that the chance of a time-consuming – and sometimes expensive – audit are greater than ever. If your clients can keep the above items in mind during the 401(k) plan’s day-to-day administration, there is a much better chance you won’t have to go through this process.

Steven E. Parmelee is the President of Westport Benefits Group, which specializes in helping 401(k) and other qualified plan sponsors understand their fiduciary roles and obligations. Fulfilling these obligations provides a natural progression to a successful retirement program and one that is best suited for each client.

The author can be reached at sep@westportbenefitsgroup.com or 203-227-3738.