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
6 www.mwe.com
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)
Not required for plans with fewer than 100 participants
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Form 5500 Schedules, continued
Schedule H (financial statement and related information,
including auditor’s report)
Not required for plans with fewer than 100 participants
Schedule I (financial statement and related information for
small plans)
Schedule R (retirement plan information, including
distributions)
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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
Sample IRS audit request
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
Sample IRS audit request
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
Sample IRS audit request
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)
Sample IRS audit request
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
Sample IRS audit request
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
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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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 33
“Before anything else,
preparation is the key to success.”
- Alexander Graham Bell
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 34
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 35
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 36
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?
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 37
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!
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 38
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 39
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 40
How do we get there?
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 41
How do we get there?
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 42
How do we get there?
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 43
How do we get there?
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
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The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 45
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:
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 46
Sample Request List
Requested Item Comments
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 47
Sample Request List
Requested Item Comments
11
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.
Requested Item Comments
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 48
Sample Request List
Requested Item Comments
17
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.
Requested Item Comments
19
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.
21
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 49
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
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2014 Crowe Horwath LLP 50
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