401k annual audits: anticipating serious and costly errors...

401k Annual Audits: Anticipating Serious

and Costly Errors, Evaluating Alternative Solutions

WEDNESDAY, MARCH 12, 2014, 1:00-2:50 pm Eastern

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401(k) Annual Audits

March 12, 2014

Brian A. Benko Joanna C. Kerpen

McDermott Will & Emery LLP McDermott Will & Emery LLP

Washington D.C. Washington D.C.

(202) 756-8047 (202) 756-8193

[email protected] [email protected]

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Governing Law

Employee Retirement Income Security Act of 1974 (ERISA)

Title I: Protection of Employee Benefit Rights

• Enforced by the Department of Labor (DOL)

Title II: Amendments to the Internal Revenue Code (IRC)

• Enforced by the Internal Revenue Service (IRS)

Form 5500 Annual Report

Published by the DOL

Used by the DOL and the IRS

Filed by all employee benefit plans

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Audit Overview – Enforcement

DOL Enforcement

Reporting and disclosure

Fiduciary standards

Voluntary Fiduciary Correction Program

Delinquent Filer Voluntary Compliance Program

IRS Enforcement

Plan qualification – formal and operational compliance

Employee Plans Compliance Resolution System (EPCRS)

• Self Correction, Voluntary Compliance Program, and Audit CAP

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Audit Overview – Procedure

General procedure for IRS and DOL audits

Selection for audit

Initial contact by the IRS or the DOL

Document request

Site visit

Additional requests

Discussion of issues

Correction of failures

Completion of audit

Form 5500 Overview

Electronic filing required annually using DOL EFAST2 system

Exceptions for certain government and church plans, and one participant plans

that have assets of $250,000 or less as of the close of the plan year

Designed to satisfy annual reporting requirements under ERISA and the

Internal Revenue Code

Requirement to file is for the plan administrator, not the plan sponsor

Single Form 5500 is filed for a single employer plan even if there are multiple

related employers participating

Participating employers in a multiple employer plan must file separate

schedules if contributions for each employer fund only that employer’s

employees

Employers must keep records of information used to prepare the Form 5500

for at least six years after the Form 5500 is filed

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Form 5500 – Small Plans

Form 5500-SF: 401(k) plans with fewer than 100 participants may be able

to file the Form 5500-SF

80-120 Rule: If a plan files as a small plan in one year, and has at least 80, but

not more than 120, participants at the beginning of the following plan year, the

plan can file as a small plan for that following plan year

The plan must also (i) be eligible for the small plan audit waiver, (ii) hold no

employer securities, and (iii) have 100% of its assets in investments that have

a readily ascertainable fair market value

Form 5500-EZ: One participant plans with assets in excess of $250,000

as of the close of the plan year must file the Form 5500-EZ

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Form 5500 Requirements

Due date is generally seven months after the end of the plan

year or short plan year (July 31 for calendar year plans)

Two and one-half month extension available by filing the Form 5558

with the IRS (extension until October 15th for calendar year plans)

Automatic extension to due date for plan sponsor’s tax return in certain

circumstances (but not later than nine and one-half months following

the end of the plan year)

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Form 5500 Requirements, continued

Part I: Annual Report Identification Information

Plan year, type of plan, type of filing, extensions

Part II: Basic Plan Information

Plan name, number, effective date, plan sponsor information, preparer

information, plan administrator information, number of participants

Electronic signature using EFAST2

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Form 5500 Schedules

Schedule A (insurance information)

Schedule C (service provider information)

Required for plans with 100 or more participants, generally for service

providers paid $5000 or more

Not required for plans with fewer than 100 participants

Schedule D (DFE/Participating Plan Information)

information on participation in pooled investment or insurance

arrangements

Schedule G (financial transaction information)


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Form 5500 Schedules, continued

Schedule H (financial statement and related information,

including auditor’s report)


Schedule I (financial statement and related information for

small plans)

Schedule R (retirement plan information, including

distributions)

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Slide Intentionally Left Blank

Potential Issues or Reasons for Audit

EFAST2 system challenges

DOL will take into account good faith attempts to file correctly

Failure to file Form 5500 or late filing

Delinquent Filer Voluntary Correction (DFVC) program available

Incomplete filing

Plan administrator can file a revised Form 5500 within 45 days of the

DOL’s notice of rejection

Failure to maintain proper records

Informal comments indicate plans should keep an actual signed copy

of the Form 5500, even though submitted using an electronic signature

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Penalties

Civil Penalties

Separate penalties can be assessed by the DOL and IRS

• DOL penalty of up to $1,100 per day (reduced penalties under the Late-

Filer and Non-Filer Enforcement Programs)

• IRS penalty of $25 per day (capped at $15,000)

Penalty for failure to file a Form 5500

• Rejected Form 5500s are treated as not filed

Criminal Penalties

Under ERISA, up to $100,000 and ten years in prison (maximum fine of

$500,000 if the entity is not an individual) for “willful” violation

Federal criminal penalties (e.g. for knowingly making a false statement or

concealing information)

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Additional Filings

Form 8955-SSA (Annual Registration Statement Identifying Separated

Participants With Deferred Vested Benefits)

Same deadline and extension rules as Form 5500

Filed with the IRS

Formerly the Form SSA

Form 8822-B (Change of Address or Responsible Party – Business)

Due within 60 days of the change in address or identity of a plan’s

“responsible party”

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DOL Audit Triggers

Participant complaints

Form 5500 review

At-risk employers vulnerable to selection for audit

Specific DOL reasons for certain audits (e.g. looking into plan

administration at certain industries)

Random selection

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DOL Audits – Document Requests

Typical Document Request includes:

Plan Document and SPD

Fidelity Bond and Fidelity Insurance Policy

Form 5500s for the past three years, and Summary Annual Report for

the previous year

Trust agreement and trustee statements for the past three years

Service provider agreements

Meeting minutes

Asset records and payroll/contribution records

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IRS Audits – Document Requests

IRS generally requests various documents and information

related to 401(k) plans

Plan and trust governing documents

Amendments (including proof of adoption)

IRS determination letter

Summary plan descriptions

Payroll records and tax forms

Documents relating to contributions

Corporate minutes relating to plan

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Plan Document Compliance

Plan, trust and amendments must comply with the law in form

Plan and trust documents

Interim amendments

IRS determination letter

Sample IRS audit request

Copies of the plan and trust documents, including the original plan and

trust documents, all amendments, adoption agreements and

restatements thereto, from the inception of the plan to the present

Copies of all determination and/or opinion letters that the plan has

received from its inception to present

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Operational Compliance

Plan must be operated in accordance with its terms and

applicable law

Most issues in an IRS audit focus on operational compliance

Common issues reviewed during an IRS audit

Eligibility and Vesting

Timing of Salary Deferrals

Compensation Definitions

ADP/ACP Testing

Distributions and Hardship Withdrawals

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Eligibility and Vesting

Properly apply eligibility requirements and vesting standards

Allow employees to participate and make elective deferrals

Vest benefits in accordance with plan terms and IRC requirements


Copy of employee census reports and/or valuation reports, which

should include date of birth, date of hire, date of termination, and total

hours worked during the year, as to each employee

Copy of payroll records used to decide employees’ eligibility and

vesting (e.g., time cards, personnel records, employment contracts)

Copies of Forms 940, 941, W-2

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Salary Deferrals

Timely deposit salary deferrals


Copies of payroll records

Copies of all cancelled checks (front and back), wire transfers or other

documentation substantiating all contributions made to the plan for the

year(s) under examination

Provide a reconciliation showing when the pay period ended, when

employees were paid, when the deposits were made and, if possible,

when the deposits were received by the custodian

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Compensation Definitions

Different compensation definitions used for various purposes

Deferrals and other contributions

Testing – 415, nondiscrimination, top heavy


Identify plan provisions that define compensation and provide an

explanation of how compensation is determined for plan purposes

Sample calculations for applying compensation definitions for various

purposes under the plan

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Nondiscrimination Testing

Compliance with actual deferral percentage (ADP) and actual

contribution percentage (ACP) tests

Properly include/exclude eligible employees

Correctly classify highly compensated employees

Compensation definition

Corrective measures taken, if any

Safe harbor requirements, if applicable

• Safe harbor notice to participants

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Nondiscrimination Testing (continued)


Copy of ADP and ACP tests, including a list of all highly compensated

employees and all eligible employees and an explanation of how the

figures on the tests correspond to the compensation and deferrals

listed on Form W-2

Sample calculations demonstrating how correction was made, if any

corrective measures taken to satisfy ADP and ACP testing

Samples of safe harbor notices sent to participants

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Distributions and Hardship Withdrawals

Administer distributions and hardship withdrawals in

accordance with plan terms


List of all participants who received a distribution and their dates of hire

and termination, as well as proof of payment/rollover, all notices

provided to terminated participants

Sample calculations showing the benefits paid to participants, including

the compensation that was used, years of service, etc.

Copies of hardship withdrawal files

Copies of Forms 1099R (statement of recipients of total distributions)

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Penalties

Threatened sanction

Loss of tax-qualified status

Audit CAP

Enter into a settlement agreement with IRS resolving compliance failure

Negotiate settlement to tailor penalty to the compliance failure

Correct compliance failure as stipulated in closing agreement

Improve internal controls prospectively

Pay fine to IRS and excise taxes, if any

End of IRS audit

The Unique Alternative to the Big Four®

401k Annual Audits Best Practices for Audit Preparation

Jen Aras, CPA

Senior Manager, Crowe Horwath LLP

Sacramento, California

916.441.1000

[email protected]

mailto:[email protected]

mailto:[email protected]


Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 33

“Before anything else,

preparation is the key to success.”

- Alexander Graham Bell



Know What to Expect

CPA performing a financial statement audit, not a

compliance audit, BUT….

Plan financial statements do include information

prescribed by ERISA

Audit will provide valuable insight to assist in any

regulatory reviews



Know What to Expect

What procedures will the auditor perform?

Obtain an understanding of the Plan

Obtain an understanding of transaction and entity level internal

controls

Perform plan level testing

Perform participant/employee level testing

Test the financial statement disclosures



Who is Running the Show?

Identify the owner of the audit process at the Plan Sponsor

Understand roles and responsibilities

What audit information will be received from TPA versus Plan

Sponsor?

Can the auditor contact the TPA directly?

Who is preparing the financial statements?

What will be the involvement of HR / Payroll / Financial

Reporting?



Communication is Key

Schedule an audit planning meeting with all parties

involved

Schedule status checks during audit fieldwork

Schedule check-ins and establish timelines for work

performed after fieldwork, leading up to engagement

delivery

Schedule an autopsy meeting at the end of the audit

Never to early to prepare for the next year!



Start With the End Goal In Mind

Expected deliverables

Audited financial statements

Form 5500

Audit Communications letter

Audit findings letter

Establish a timeline for the audit

Audit package available from the TPA

Regulatory filing dates

Oversight Committee meeting dates



How do we get there?

Know your plan

Understand how information is processed and who is involved

Document what you do

Initial or sign off as prepared, with the date

Have an independent review documented

If the auditor cannot see it, then it did not happen




Keep notes from prior audit

What information was needed late in the game?

What were the hold ups to the audit process?

Ask for samples of internal control documentation or checklists

the auditor is using

Will help you be prepared for questions in the field

May help you to identify additional controls to add to your plan

operations




Perform your own reconciliations and testing procedures

Contributions sent to the plan

Distributions from the plan

Plan transfers

Changes in investment options

New participants to the plan

Changes in participant data




Ask your auditor for a checklist of information they will

request

Don’t be overwhelmed by the request list

Traditional reporting package will meet the majority of the

auditor’s needs

Footnote disclosure requirements are standard, but audit

procedures are not

Audit standards require a degree of unpredictability in

procedures as well




Obtain SOC 1 / SSAE 16 reports from your service providers for

the period under audit

TPA / custodian / recordkeeper

Payroll

Valuation

Review the SOC 1 report

Audit report

List of controls tested

Exceptions and potential impact on your plan

User controls



Sample Request List

Requested Item Comments

1A copy of the plan document and copies of any amendments to

the plan, if applicable.

DOCUMENTATION: Plan document and all

amendments should be SIGNED and DATED

2A copy of the most recent IRS determination letter.

DOCUMENTATION: Keep recent and prior letters.

Read for any exceptions.

3 Copies of the minutes of any Board of Director or Committee

meetings that related to the Plan.

DOCUMENTATION: Memorialize key decisions such

as approval of PS contributions, changes to

investment mix, plan amendments. This

documentation will serve as evidence of fiduciary

oversight

4Inform auditors of any litigation related to the Plan or any attorneys

that were used for Plan matters (i.e. Plan amendments).

Maintain copies of invoices and correspondence for

Plan-related litigation or other Plan matters

5

Copies of the final tax discrimination tests for the plan.

DOCUMENTATION: Evidence that someone

reviewed and documentation of corrective measures

taken. Show evidence of review and approval.

6

Plan’s “CENSUS”: A list of all employees employed at any time

during the plan year. This list should include name, social security

number (or employee number), date of birth, date of hire, date of

termination, compensation, employee deferrals, and employer

contributions, if applicable. In addition, please provide a

reconciliation of total compensation from this listing to total wages

per the W-3 for the year or per the year end payroll report.

DOCUMENTATION:

Reconciliation of total compensation from this

listing to total wages per the W-3 for the year or

per the year end payroll report.

Ensure deferrals match the trust records

If ER contributions, ensure they match deposits

to the trust

Evidence of review!

Plan – Level Documents:



Sample Request List


7 Trust statements from your Custodian or Recordkeeper

A member of management should review these

annual and quarterly statements to ensure they

meet expectations. DOCUMENTATION: Initial

and Date evidencing review.

8

Form 5500.

A member of management should review for

accuracy. If your plan is audited, compare the

balances to the audit report.

DOCUMENTATION: Initial and Date evidencing

review.

9

If your Plan is audited, support for investment fair value

disclosure, including management’s analysis of classification

for level 1, 2 or 3 investments. This is important if your Plan

invests in Level 3 investments, i.e. Partnerships or private

stock.

Sponsors may not just rely on their Custodian or

Trustee. What has management done to validate

the accuracy and timeliness of values?

10

Original documentation supporting loan activity for the Plan

Documentation: Signed request form AND

approval.

Plan’s Financial Information



Sample Request List


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Personnel records verifying date of birth and date of hire.

Please note that we prefer a document that was

prepared and signed by the employee, such as an

application or enrollment form.

Personnel files shall be kept current. Auditors look for

support for demographic information AND support for

participant’s pay. Common errors: No pay rate changes

in files.

12If an employee is eligible to participate in the Plan,

please provide his or her election form indicating that he

or she accepted or declined participation.

Auditors are looking for validation of appropriate

inclusion or exclusion from the Plan. Sometimes this

documentation is electronic and maintained by the

Custodian.

13What controls does the sponsor have in place to “check”

for correct eligibility?

Consider testing/spot-checking. Also, keep a “narrative”

of the controls over this process.


14Provide a schedule for all contributions remitted to the

trust during the year, including those amounts that were

paid subsequent to year end.

Documentation: Keep a list evidencing date payroll

withheld, verification that what left the payroll made it to

the plan and record of timeliness. Establish strong

controls over timeliness.

15 Provide support for the contributions made to the Plan,

such as wire transfer support.

Documentation: Keep support AND approval for such

transfers.

16 Provide the formula for calculating EE and ER

contributions for the plan year.

Common errors: Wrong definition of compensation,

incorrect ER Profit Sharing contributions. Perform spot-

checks. Keep documentation.

Eligibility Testing

Contribution Testing



Sample Request List


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A list of all participants who received distributions from

the Plan. This list should include the participant’s name,

the amount of the distribution, and the date of the

distribution.

Documentation: Auditors will test that distributions were

appropriately requested by the participants, spousal

consent was obtained if applicable AND the distribution

was approved. Sometimes this occurs at the Custodian

however, Sponsors should spot-check listings to see if

anything appears unusual. An initialed listing/notation

would be evidence of review.

18A list of all expenses paid by the Plan for the year

including service provider and amount paid.

Many plans don’t pay expenses however, evidence of

approval is important if paid out of Plan.


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Correspondence with the Department of Labor and/or

Internal Revenue Service related to the Plan and a copy

of your response.

Documentation of response. Committee approval may

be appropriate.

20

A copy of communications from your auditor regarding

any Plan deficiencies or weaknesses and your planned

response

Documentation of how Sponsor plans to fix, evidence of

fix or written response.

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A copy of the most recent “Report on controls Placed in

Operation” or “Report on Controls Placed in Operation

and Tests of Operating Effectiveness” (SSAE 16 Report)

for any service providers.

Evidence of management’s review and comments on

any exceptions noted. Will exceptions impact your

plan?

Distribution Testing

Other Items



Most Common Audit Findings

Some errors and audit findings persistently surface

Errors or inconsistency in the definition and application of

compensation

Inconsistency in the timing of remitting participant deferrals

Lack of documentation of controls in place at Plan Sponsor

Reconciliations and independent reviews

Meetings of those charged with governance



For more information, please contact: Jen Aras, CPA

Senior Manager, Audit Services

Crowe Horwath LLP

400 Capitol Mall, Suite 1400

Sacramento, California

916.441.1000

[email protected]