When Does a 401k Plan Need an Audit?

A 401(k) plan audit is a formal review of a company’s retirement plan conducted by an independent accounting firm. Its primary purpose is to ensure the plan adheres to regulations set by the Internal Revenue Service (IRS) and the Department of Labor (DOL), and that it operates in accordance with its plan documents. These audits safeguard participant interests by verifying the financial integrity and compliance of the plan. They also help confirm the accuracy of financial information reported on the annual Form 5500.

Determining Audit Requirement Based on Participant Count

A 401(k) plan generally needs an audit when it qualifies as a “large plan” for Form 5500 reporting purposes. This occurs when a plan has 100 or more participants with account balances as of the first day of the plan year. Plans with fewer than 100 participants are considered “small plans” and are exempt from this annual audit requirement.

The audit requirement is a regulatory measure mandated by the Employee Retirement Income Security Act of 1974 (ERISA). This legislation aims to protect employee retirement assets by ensuring plans are managed responsibly and transparently. If a plan meets the 100-participant threshold, an independent auditor’s report must be attached to its annual Form 5500 filing. Failure to comply can lead to significant penalties and increased regulatory scrutiny.

For calendar-year plans, the Form 5500, along with the audit report, is generally due by July 31st of the following year, with a possible extension until October 15th. The audit process can take several weeks to months, making early engagement with an auditor advisable.

Defining Plan Participants for Audit Purposes

For plan years beginning on or after January 1, 2023, the participant count for audit purposes is based solely on the number of individuals with an account balance in the plan as of the first day of the plan year. This updated methodology simplifies the counting process compared to prior rules that included all eligible participants, regardless of whether they had an account balance. This count includes active employees who have an account balance. Additionally, individuals who are no longer employed by the company but still maintain a balance within the plan, such as terminated or retired employees, are included in the participant count. Beneficiaries of deceased participants who have an account balance or are receiving benefits from the plan also contribute to the total.

Special Rules and Exemptions

The “80-120 Participant Rule” provides flexibility for plans whose participant counts fluctuate around the 100-participant mark. If a plan had fewer than 100 participants in the prior year and filed as a “small plan,” it can continue to file as a small plan (and potentially avoid an audit) even if its participant count crosses 100, as long as it does not exceed 120 participants at the beginning of the current plan year. Conversely, if a plan had 100 or more participants in the prior year and was required to file as a “large plan,” it must continue to do so, including undergoing an audit, until its participant count drops below 100.

Another consideration involves short plan years, which occur when a plan year is less than 12 months. If a short plan year is seven months or less, the audit requirement for that period may be deferred to the following year. However, this is a deferral, not an elimination, meaning the subsequent year’s audit would cover both the short period and the full year.

Some audits, while still mandatory, may be performed as an ERISA Section 103(a)(3)(C) audit, which replaced the term “limited scope audit.” This type of audit allows the auditor to rely on certifications from qualified institutions (like banks or insurance companies) regarding the accuracy of investment information. While this can streamline certain aspects of the audit, it does not remove the overall audit requirement; the plan still needs an independent audit.