Auditing 401(k) Plans

Partial Plan Termination

Partial Plan Termination

A partial plan termination can occur if approximately 20% or more of the plan participants are terminated by the plan sponsor as a result of an action such as a plant closing, downsizing or termination of a product line.  These terminations can accumulate over one or more years and still be considered a partial plan termination.  When a partial plan termination occurs, the affected participants are 100% vested at the termination date.

 

 

 

 

 

 

 

 

 

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Hardship Distributions

Hardship Distributions

If a 401(k) plan provides for hardship distributions, the plan document must provide the specific criteria used to determine the need for a hardship.  To qualify for a hardship distribution, the employee must have an immediate and heavy financial need and the amount requested must be necessary to satisfy the financial need.  AFter an employee receives a hardship distribution, the employee will be prohibited from making elective contributions to the 401(k) plan for at least 6 mnths after the hardship distribution.

 

 

 

 

 

 

 

 

 

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Fraud

Fraud

Unfortunately, many auditors think that employee benefit plans have little or no risk of fraud.  Fraud can occur in employee benefit plans just as easily as a corporation or non-profit entity.  Auditors of 401(k) plans must maintain the proper level of professional skepticism as required by AU 316.

 

 

 

 

 

 

 

 

 

 

 

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  • You should know…

    ”Large” 401(k) plans, generally meaning those plans with 100 or more participants, must file an audit with the annual Form 5500.
    Common audit deficiency - failure to properly report on and/or include the required supplemental schedules relating to ERISA and DOL.
    Common audit deficiency - failure to test eligibility to receive benefit payments.
    Generally, a plan is considered a “large” plan if it had 100 participants at the beginning of the plan year and a “small” plan if it had fewer than 100 participants at the beginning of the plan year.
    Common audit deficiency - inadequate or missing disclosures.
    Common audit deficiency - failure to understand testing requirements on a limited-scope engagement.
    Common audit deficiency - no audit work performed for related parties.
    Common audit deficiency - failure to obtain proper certification for a limited scope audit.
    Common audit deficiency - no audit work performed for contributions.
    The DOL and the AICPA indicate that 401(k) audits have an unnacceptably high rate of deficiencies and the DOL can reject any Form 5500 with a deficient audit.
    Common audit deficiency - inappropriate reliance on SOC 1 reports.
    Plans whose sole assets are insurance contracts that fully guarantee benefit payments are not required to be audited.
    Under the “80-120 rule”, if a plan has between 80 and 120 participants as of the beginning of the plan year, it may elect to file the same category (Schedule H or Schedule I) of form 5500 it filed the year before.
    The “80-120 rule” will allow the plan to continue to file as a “small” plan (and avoid the audit requirement) indefinitely until the plan exceeds 120 participants at the beginning of a plan year.
    Common audit deficiency - testing of payroll data is insufficient.
    Common audit deficiency - no audit work performed for benefit payments.
    Common audit deficiency - failure to test employee deferrals.
    Common audit deficiency - failure to test timeliness of participant contributions
    Common audit deficiency - no testing of participant eligibility or forfeitures.
    A “large” plan will file a Form 5500 with a Schedule H and a “small” plan will file a Form 5500 with a Schedule I.
    The auditor of a 401(k) plan must be familiar with ERISA, tax, and DOL laws and regulations and they must be familiar with special requirements of 401(k) plans.
    Common audit deficiency - improper use of limited scope exemption because financial institution did not qualify for such an exemption.
    “Large” plans that have a short plan year of seven months or less may elect to defer (but not eliminate) the audit requirement.
    Common audit deficiency - no testing of investment income allocation to participants.
    Common audit deficiency - no audit documentation for testing participant data.
    Administrators of a 401(k) plan subject to ERISA must file an annual report (Form 5500).
    It is important for the auditor of a 401(k) plan to have the knowledge, proficiency and competency to perform an efficient and effective audit which will stand up to the scrutiny of the DOL.
    Quality audits for 401(k) plans are imperative, not only because they help ensure plan compliance for the benefit of the participants, but quality audits are important because the DOL can reject the annual Form 5500 filing when the DOL determines an audit failure has occurred.

Economic Conditions

When a downturn in the economy occurs, the incentive to commit fraud increases. Because of the characteristics of fraud, the auditor’s exercise of professional skepticism is important when considering the risk of material misstatement due to fraud.

There are two types of fraud associated with employee benefit plans: fraudulent financial reporting and misappropriation of assets.  Specific areas of concern might be the improper valuation of investments, defalcations, inappropriate vesting of participants, ineligible participants included in the plan, and inappropriate benefit disbursements.

Plan administrators must also be aware of the possibility of a partial termination when a downturn in the economy causes layoffs at the plan sponsor. When a partial termination occurs, the Internal Revenue Code requires that all affected participants become fully vested. A partial termination is a technical term that does not have a clear definition but has generally been interpreted to apply when 20 percent or more of the workers have lost their jobs due to an event such as a plant closing or general layoffs. Because many 401(k) plans use forfeitures to reduce employer contributions or to pay expenses, it is important for the plan administrator to properly identify when a partial termination has occurred.

The trend of participants withdrawing money from their 401(k) accounts due to hardship is expected to continue as the economy continues to struggle.  If the hardship distributions are significant to the plan, they may need special consideration during audit because hardship distributions are generally processed differently than other types of distributions.

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