Summary: Employers gain many benefits by sponsoring an employee benefit plan, but they also face high costs. One cost that often surprises plan sponsors is the independent audit that is required once the plan reaches a certain size. What do you need to know?
The short answer: if your plan has 100 or more participants at the start of the plan year, it generally must be audited. But how you count participants depends on the type of plan you sponsor, and a few exceptions can change the result.
The good news is that you can usually tell whether an audit applies well before it is due. That gives you time to budget for the cost, select an auditor, and get organized in advance. As a general rule, your Form 5500 and the audit report, when required, are due seven months after your plan year ends, and you can extend that deadline by another two and a half months.
What Does It Mean?
If you are unsure where your benefit plan stands, consider the following questions:
1. ERISA coverage
Is your plan subject to ERISA? If not, the Form 5500 or audit is not required.
2. Participant count
Did you have 100 or more participants at the start of the plan year? If you have fewer than 100, this generally means no audit. However, the 80-120 rule below can apply.
3. Plan type
Counting works differently for defined contribution, defined benefit, and welfare plans.
4. Welfare funding
Fully insured or unfunded welfare plans usually do not need an audit, even above 100 participants.
5. Exceptions
The 80-120 Participant Rule or a short plan year can change or defer the requirement.
Additionally, here is how the participant count works for each plan type:
- 401(k) plans and ESOPs (defined contribution): count everyone who still has an account balance in the plan.
- Traditional pensions (defined benefit): count all participants such as active employees, former employees entitled to future benefits, retirees receiving benefits, and their beneficiaries.
- Health, disability, and other welfare plans: count all participants, but whether an audit is required at all often depends on how the plan is funded.
How Does the Audit Requirement Work?
If you sponsor a benefit plan subject to the Employee Retirement Income Security Act of 1974 (ERISA), you are required to electronically file an annual report with the Internal Revenue Service and the Department of Labor using the proper Form 5500 series of forms. The Form 5500 instructions, Section 1: Who Must File, is an excellent resource that can help determine if your plan meets any of the exceptions to the requirements for filing a return. If it turns out that you need to file, there are specific schedules required to be included depending on the nature and size of your plan.
The audit requirement is triggered when the plan must file as a “large plan”, as defined by the instructions to the Form 5500, because a Schedule H (the detailed financial schedule that accompanies a large plan’s filing) is required to be attached. So, when are you a “large plan”?
Your status as a large plan filer is usually determined by your participant count at the beginning of the plan year. If you have 100 or more participants on that date, you would be considered a “large plan” for filing purposes (see exception below). The specific rules are as follows:
Defined contribution plans (401(k)s and ESOPs)
For a defined contribution plan, the count is the number on Line 6g(1): the number of participants with account balances. If this is the plan’s first return, it is the number on Line 6g(2): the number of participants with account balances at the end of the plan year. As such, any participant who still has funds in the plan is counted.
For sponsors who are approaching the trigger point, it is important that you monitor your census and take action to encourage terminated participants to take distributions from the plan and to use any small-balance force-out provisions, which let the plan automatically distribute very small account balances. It is also recommended that you collect personal contact information for terminating participants with account balances before they leave employment and communicate regularly with them about their remaining funds so that they do not become “lost participants.” Tracking these participants can be challenging but remains a plan sponsor responsibility.
Defined benefit plans (traditional pensions)
For a defined benefit plan, the count is the number on Line 5 of the 5500: total number of participants at the beginning of the plan year. Line 5 includes active employees currently earning/retaining credited service, former participants currently receiving benefits, former participants entitled to future benefits, and deceased individuals whose beneficiaries are receiving or are entitled to future benefits.
This type of benefit plan requires a careful review of the census provided to the actuary regularly to help ensure the counts used are accurate.
Welfare benefit plans (health, disability, and similar)
For a welfare benefit plan, the count is also the number on Line 5 of the 5500: the total number of participants at the beginning of the plan year. An individual meets the definition of a participant on the earliest of these dates:
- The date designated by the plan as the date participation begins.
- The date they become eligible (subject only to occurrence of the contingency for which the benefit is provided).
- The date the individual makes a voluntary or mandatory contribution to the plan.
Covered dependents are not included in the count, but participants receiving continuation of benefits under the Consolidated Omnibus Budget Reconciliation Act (COBRA) are counted. One of the hardest determinations for welfare plans is not always the count, but whether an audit is needed in the first place.
The audit is not needed even if the count exceeds 100 if the plan is unfunded (benefits paid through the general assets of the sponsor), fully insured (benefits paid through insurance contracts, the premiums of which are paid directly by the sponsor), or a combination of both. If a separate account has been set up, you may risk triggering the audit requirement. The advice of ERISA counsel may be warranted to reduce the chance of filing errors.
What are the Two Important Exceptions?
One exception to the above counts is the “80-120 Participant Rule”. If the count is between 80 and 120 and a Form 5500 was filed in the prior year, you can elect to continue filing in the status (“large plan” or “small plan”) that you did in the prior year.
Example: If you had 90 participants at the start of the prior plan year and you filed as a “small plan” filer, and at the start of this plan year you have 104 participants, you can file as a “small plan” filer for this year. You may continue to do so as long as your count does not exceed 120, and an audit would not be required until you must file as a “large plan”.
One additional exception to note for audit purposes relates to short plan years. If the plan has a short plan year of seven months or less for either the prior plan year or the current plan year, the auditors’ report can be deferred. This is important in the plan’s initial and final years.
1. Initial-year example
If your initial plan year is August 1, 20X1 to December 31, 20X1, and your participant count would require filing as a “large plan”, your 5500 would typically be due no later than October 15, 20X2 (assuming an extension) with a Schedule H and an auditor’s report.
You can elect to defer the audit for this period by checking a specific box on the 20X1 Form 5500 Schedule H when filed. You would then file your 5500 for the 20X2 plan year with an auditor’s report that covers both the August 1, 20X1 to December 31, 20X1 period and January 1, 20X2 to December 31, 20X2 period. This would be due no later than October 15, 20X3 (assuming an extension).
2. Final-year example
A similar deferral is available in final years, as long as the final year is less than seven months. In this case, the 5500 for 20X3 calendar plan year would be filed no later than October 15, 20X4 (assuming an extension), checking the box on Schedule H electing deferral, and the 5500 for plan year January 1, 20X4 to the date of termination (must be before or on July 31, 20X4) would be filed no later than 9½ months (assuming extension) after date of termination with an auditors’ report that covers both 20X3 plan year and the 20X4 short plan year.
Combining the audits so they are done simultaneously can sometimes result in lower audit fees and efficiency, depending on the plan circumstances.
Final Thoughts: Preparing Your Benefit Plan
One good thing about how these counts are determined is that you should be able to determine if an audit is needed well before the actual audit. You can find an auditor, budget for the cost, and make sure you are ready. Being proactive is one way to stay ahead of the high cost of unknowns. If you have questions about your plan, reach out to the Aprio Employee Benefit Plan Assurance team, and we can help you plan.
