The Art of the Qualified Plan Audit

Posted by Maria T. Hurd, CPA

Checklist for Counting Participants as of the Beginning of the Year

Many nonprofits who sponsor ERISA 403(b) plans are not aware that they need an audit, because counting participants involves much more than knowing how many full-time employees the organization has or how many account balances are in the plan. Especially in the case of nonprofit organizations, the universal availability rules and the ability to exclude certain contracts pursuant to DOL Field Assistance Bulletin 2010-1 add a layer of complexity that requires the employer to give careful consideration to the participant count.

To assist 403(b) plan sponsors in computing an accurate participant count as of the beginning of each year, we have created the following step- by-step checklist:

Each step on the list above results from specific legislation regarding the correct way for a 403(b) to count its participants as of the beginning of the year.  An accurate participant count is an important first step in determining whether an ERISA plan needs to attach audited financial statements to their Form 5500. Large ERISA plans must engage an independent qualified public accountant (IQPA) to audit the plan’s financial statements.  Most small plans are not required to have audited financial statements. For more detail on the rules affecting each step of this determination, please refer to our previous blog entries:

Counting Participants is not as easy as 1, 2, 3! - From The Art of the Qualified Plan Audit

403(b) Plans: Universal Availability Exclusions – From The Art of the Qualified Plan Audit

Field Assistance Bulletin No. 2010-01 – From the United States Department of Labor

A Nonprofit’s Guide to Navigating the ERISA Audit Requirements – From The Belfint Nonprofit Ledger

I don’t want to grow up, I want to be a small plan! – From The Art of the Qualified Plan Audit

BLS is available to assist any ERISA 403(b) plan sponsors who need assistance with this complicated determination. Contact me at 302.225.0600 or mhurd@belfint.com.

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Posted by Saaib Uppal, CPA

As discussed in a previous blog post, How to stop a nonelective contribution, circumstances and factors often arise that make us wish that a commitment we made had an escape clause. The commitment we were discussing in that post was a safe harbor nonelective contribution. At the time, we referenced the IRS regulations that had been proposed on May 18, 2009 to provide guidance on stopping nonelective contributions as follows:

• The sponsor must incur a substantial business hardship which is defined as including (but not limited to) whether or not:
  • The employer is operating at an economic loss;
  • There is substantial unemployment or underemployment in the employer’s trade or business; and
  • The sales and profits of the employer’s industry are depressed or declining.
• The plan must be amended to provide that it satisfies both the ADP and ACP tests for the entire plan year using the current year testing method, regardless of the fact that safe harbor contributions were made for part of the year;
• All safe harbor contributions must be made, up until the effective date of the amendment;
• The reduction or suspension of the nonelective safe harbor contribution may not be effective earlier than 30 days after delivery to the eligible employees of a notice containing the information described below (or 30 days after the amendment is adopted, whichever is later);
• Eligible employees must be given a reasonable opportunity to change their existing deferral elections after receipt of the notice, but prior to the effective date of the amendment;
• The notice to eligible employees must contain an explanation of the following:
  • The consequences of the amendments reducing or suspending future safe harbor nonelective contributions;
  • The procedures for changing the employee’s deferral election and, if applicable, employee contribution elections; and
  • The effective date of the amendment to the plan which suspends and/or reduces the nonelective safe harbor contribution.

While this did make it easier for plan administrators to back out of their nonelective contribution commitment (as opposed to the alternative of terminating the plan), proving a substantial business hardship can be difficult at times. To provide further assistance, the November 15, 2013 final regulations on reducing or suspending 401(k) plan safe harbor nonelective contributions mid-year were released.

To summarize these new regulations, employers can rescind their commitment if:

1)      They can prove that they are “operating at an economic loss,” OR

2)      The annual safe harbor notice states that the safe harbor contributions could be reduced or suspended upon later notice.

The second option is a welcome change and as long as employers provide a supplemental notice at least 30 days prior to adopting any amendment to reduce or suspend the contributions, they will be deemed to have satisfied the final regulations. This essentially turns the annual safe harbor notice into a “Maybe… Maybe Not” notice which goes a step further than the “Maybe” notices we wrote about in Maybe Notices for Safe Harbor Plans.

Where’s the escape clause if you wish to reduce/suspend a safe harbor matching contribution? For plan years beginning January 1, 2015, you can follow these same rules outlined above. Until then, you must continue to follow the steps discussed in How to Scratch that Match.

An important consideration in deciding whether to suspend employer contributions is that the plan will then be subject to nondiscrimination testing which could cause the highly compensated employees to receive a distribution of excess salary deferral and matching contributions. Additionally, a required top-heavy contribution could force the employer to make a 3% top-heavy minimum contribution, almost identical to the nonelective safe harbor contribution that is suspended in the first place.

Whether we can implement a “Maybe…Maybe Not” clause in our other commitments in life remains to be seen. For plan administrators, however, the IRS has provided an option to opt-out mid-year that is sure to be well received.

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Plan audits are critical. Join Legg Mason for a webinar with Maria T. Hurd, CPA, Director of Retirement Plan Audit Services at Belfint, Lyons & Shuman. Maria will offer insights to help plan sponsors and advisors prepare for a plan audit by providing a road map to help determine:

• Whether an audit is required
• Whether it can be limited in scope, and what that means for the plan
• How to select an auditor with the proper expertise

Date: Monday, March 31, 2014

Time: 4:00pm EST

Host: Gary Kleinschmidt, Head of Retirement Field Sales, Legg Mason

Webinar: Click to start the webinar to view the slide presentation

Meeting Password: legg

Dial In Number: 877-456-4467

Conference ID: 10523501

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Posted by Saaib Uppal, CPA

Imagine you come home from school after graduation and you see your mother beaming with a huge smile on her face. She asks to see your diploma (a certificate of completion in this example) and you oblige and move on to show your father the same. “Great,” he says, “but where is your report card?” With a confused look on your face, you reach for the report card and hand it over. After he has had a chance to look it over and is pleased, you walk away wondering why it took both to satisfy your parents. A diploma and a report card both show success and it should have been an either/or situation, no? The truth is that they are not mutually exclusive and both are required in order to get an accurate picture. Now, replace your graduation with a retirement plan audit and substitute the diploma and report card with a certification letter and a SSAE 16 report, respectively. Lastly, the parents in our situation can be equal to, if not scarier than, the Department of Labor.

So what makes both documents unique and important? Let’s start with the SSAE 16 report. This is required when relying on the internal controls of a subservice organization, irrespective of whether you are getting a full- or limited-scope audit. This report allows your auditor to gain an understanding of internal controls and assess the risk of material misstatement on the financial statements. This report should, of course, cover the same period of the audit. If there is a gap in the dates, the appropriately named “gap letter” from the service organization will suffice as a supplement to the report. The SSAE 16 report allows the auditor to reduce, but not eliminate, audit testing in audit areas covered by the report.

What purpose does the limited-scope certification serve? This certification helps meet DOL Regulation 29 CFR 2520.103-8. With this document, the plan administrator can instruct its auditor to not perform any auditing procedures to the certified investment information. Said information is considered to be certified by a qualified institution as to both its completeness and accuracy. As a result, the limited-scope certification allows the auditor to exclude ONLY investment values and investment earnings from the scope of the audit, but NOT ANY OTHER AUDIT AREA.

More information on limited-scope audits can be found in one of our previous blog entries, Limited-Scope Audits. Just as not providing what your parents ask for can get you in trouble, performing a limited-scope audit because an SSAE 16 report is available, but without a limited-scope certification, can lead to severe consequences with the Department of Labor and the AICPA. It is important to understand the purpose and value of each of these documents to avoid the misconception that they are one and the same.

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Posted by Maria T. Hurd, CPA

Financial advisors on TV and financial publications in reputable papers and magazines consistently encourage people who participate in an employer-sponsored retirement plan to contribute as much as possible. In many cases, retirement plan platforms offer online tools to assist plan participants in projecting how much they need to save to achieve high income replacement levels when they get to retirement age. Therefore, it is not surprising that highly compensated employees (HCEs) are shocked to hear that they are not permitted to contribute as much as they elected. The refunds they receive when their employer’s plan fails the Actual Deferral Percentage (ADP) and Aggregate Contribution Percentage (ACP) tests leave them puzzled and confused.

The simple explanation for the unexpected refunds is that the IRS wants to ensure that the contributions deposited in the accounts of non-highly compensated employees (NHCEs) are proportional to contributions made for HCEs. Counterintuitive as it may seem to the surprised HCEs, the nondiscrimination rules apply to the elective 401(k) deferrals that they contribute out of their own salary (ADP test) as well as to the match contributions they receive from the employer (ACP test).

As the NHCEs contribute more into the plan, the HCEs are allowed to contribute more into the plan, up to the legislative maximum limits. For example,

Discrimination Test Refunds

The plan distributes the excess contributions to HCEs, to lower their average percentage contribution until the test is passed. The distributions are made first to HCEs who deferred the highest dollar amounts, not the highest percentage, and they must include earnings. If distributed within 2 ½ months of the end of the plan year, there is no tax penalty to the employer. If returned after 2 ½ months, the employer is subject to a 10% excise tax. HCEs report the distribution as taxable income in the year in which the excess is distributed.  The recipients of the excess contributions receive a Form 1099-R to facilitate their tax reporting.

It is important to note that 403(b) plans are not subject to the ADP test, but they are subject to the ACP test, which is the same as the ADP test described above, but computed using the employer match contributions. Excess match contributions are called excess aggregate contributions and they are refunds to the HCEs. They are processed in the same way as excess deferral contributions, except that excess match contributions that are not fully vested are reallocated to other participants or forfeited to an unallocated suspense account to reduce future contributions.

Plans can base the ADP and ACP percentages for NHCEs on either the current or the prior year contributions.  The election to use current or prior year data is contained in the plan document. A plan can change from prior year testing to current year testing during any plan year, but once current year testing is elected, the employer cannot change back to prior year testing except under limited circumstances.

Other Highly Compensated Employee Refunds

Refunds of excess contributions are not the only alternative available to employers whose plans have failed the ADP and/or ACP tests. Other options include additional vested contributions to the NHCEs and, prospectively, the plan’s third party administrators and/or ERISA counsel can assist the client in reviewing alternative plan designs that achieve the employer’s objectives in a more cost-effective manner. In many cases, the HCEs receiving the refunds are not in a position to influence the corrective method selected by the employers. In cases when refunds of excess contributions are processed, plan officials have to be prepared to explain why contributing as much as possible is encouraged by the media, but the maximum limits can be lower than expected if the plan does not pass the non-discrimination tests.

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Posted by Christopher J. Ciminera

When I was younger my little sister would come to the park with my friends and me. One day I was walking back with my friends and realized I forgot my sister who was left playing with friends. Unlike retirement plans, most welfare plans are a combination of unfunded and fully insured, so they don’t file a Schedule H with plan financial information, and they do not have to attach audited financial statements to the Form 5500 filing, so large welfare plan sponsors often forget the filing requirement, just like I forgot my little sister.

As a testament to this, someone recently asked me about the requirement of file 5500s for its health and long-term disability plans. It appears the Department of Labor (DOL) has identified lack of welfare plan filings as a potential problem, since there have been a few articles indicating that the DOL has started a program to curtail such non-compliance. Like the reminder from my mom prior to forgetting my sister, the DOL is reminding plan sponsors by sending e-mail notifications to plan sponsors who have filed a 5500 for their retirement plan but have not filed a 5500 for their health and welfare plan. The mandated electronic filing requirements have allowed the DOL to pick out these red flags much more easily.

You may wonder, why is it a red flag to the DOL if a retirement plan 5500 has been filed, but 5500 for a health and welfare plan has not? Well, the requirements for both are that the plans must file a 5500 if the plan benefits 100 or more participants. If a 5500 is filed for a retirement plan, then the retirement plan benefits over 100 employees. Generally a health and welfare benefit plan will cover those same retirement plan participants and thus need to be reported to the DOL.

Let’s discuss the requirements for a health and welfare benefit plan to file a 5500.

A health and welfare plan that covers 100 or more employees and is covered by ERISA is required to file a 5500. The 5500 instructions list welfare plan benefits as medical, dental, life insurance, short- and long-term disability, to name a few.

There are exceptions to the requirement for a health and welfare benefit plan covered by ERISA to file a 5500.

The exceptions listed in the 5500 instructions are:

1.  A welfare benefit plan covering fewer than 100 participants at the beginning of the plan year and is unfunded, fully insured, or a combination of insured and unfunded.

a.  Unfunded – benefits paid as needed directly from the general assets of the employer or employee organization that sponsors the plan.

b.  Fully Insured – benefits provided exclusively through insurance contracts or policies, the premiums of which must be paid directly to the insurance carrier by the employer or employee organization from its general assets or partly from contributions by its employees or members.  The insurance contracts or policies discussed above must be issued by an insurance company or similar organization (such as Blue Cross, Blue Shield or a health maintenance organization) that is qualified to do business in any state.

c.  Combination unfunded/insured – benefits provided partially as an unfunded plan and partially as a fully insured plan.  As an example, a welfare plan that provides medical benefits as in an unfunded welfare benefit plan and life insurance benefits as in a fully insured plan.

Plans are NOT unfunded if they received employee contributions, except for cafeteria plans.

2.  A welfare benefit plan maintained outside the US primarily for persons who are nonresident aliens.

3.  A governmental plan.

4.  An unfunded or insured welfare benefit plan maintained for a select group of management or HCE (which meet certain requirements).

5.  An employee benefit plan maintained only to comply with workers’ comp, unemployment comp, or disability insurance laws.

6.  A welfare benefit plan that participates in a group insurance arrangement that files a Form 5500 on behalf of the welfare plan.

7.  An apprenticeship or training plan (which meet certain requirements).

8.  An unfunded dues-financed welfare benefit plan.

9.  A church plan.

10.  A welfare benefit plan maintained solely for a) an individual or an individual and his or her spouse, who wholly own a trade or business, whether incorporated or unincorporated, or b) partners or the partners and the partners’ spouses in a partnership.

There are a number of exceptions and specialized terms. It is best to discuss this with those who are familiar in this area to determine if the health and welfare plan meets one of the above exceptions.

So, in conclusion, don’t forget to file your organization’s “little sister” health and welfare plan 5500 filings. Although my mother’s admonishment for forgetting my sister was pretty bad, I know the DOL is worse if you forget your “little sister” health and welfare plan filing.

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Posted by Maria T. Hurd, CPA

Welfare plans such as health, life insurance, dental, vision, short and long term disability plans, are usually a combination of unfunded and fully insured. Unlike retirement plans, small welfare benefit plans do not have a filing requirement if the plan is unfunded, fully insured, or a combination of unfunded and insured. As a result, sponsors of growing plans that reach the 100-participant mark for the first time often miss their filing requirement. Welfare plans cannot use the 80-120 exception to delay the filing of a Form 5500, because this rule is only available to plans that filed a Form 5500 in the previous year. For more details on the application of the 80-120 rule, see our previous blog “I don’t want to grow up, I want to be a small plan.”

Welfare benefit plans that cover 100 or more participants must file a Form 5500. Some welfare benefit providers prepare the Form 5500 for their clients, others just send the required Schedule A attachments. Large plan sponsors who are not aware of the purpose for the Schedule A sometimes file the form away, not realizing that it is an indication that they must file a Form 5500. In most cases, employers who file a large plan Form 5500 for their requirement plan also have a welfare plan filing. The bad news is that electronic filing through EFAST 2 has made it very easy for the Department of Labor (DOL) to locate large plan sponsors who filed a Form 5500 for their retirement plan, but did not do so for their welfare plans.

The good news is that plan administrators who have not been notified in writing by the DOL of their failure to file a timely Form 5500 can file under the DOL’s Delinquent Filer Voluntary Compliance Program (DFVC). Under the DFVC program, the $10/day penalty for late filings, without regard to extensions, is capped at $2,000 per filing and $4,000 per plan for large plans. Although $4,000 could be a substantial penalty amount, it is often much less than the penalty that will be due if the employer doesn’t beat the DOL to it. The DOL’s website has guidance for the completion of a delinquent filing through the DFVC program. Additionally, our next blog entry will expand on the specific rules regarding the filing requirements for welfare plans. With the advent of electronic filing, it doesn’t pay to duck and cover. Sooner or later, the DOL will find your missing Form 5500, so it’s best to race them to the finish and get compliant.

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Posted by Maria T. Hurd, CPA

Were your 401(k) and 403(b) deferral deposits accurate and timely?

Picture this: it’s the last day of January and another deadline has been met successfully. Employees have their W-2s and everyone is happy.

Despite the relief payroll managers and retirement plan officials may feel from this most recent sprint to the finish, THE RACE IS NOT OVER. Before sitting down, get that second wind and verify that deferral withholdings were actually deposited to the plan, without exception. To do so, proceed as follows:

1. Make a list of each pay date during the year and the related deferral amount for each paycheck. Please note that paycheck dates for 2013 must be included, NOT pay periods.
2. Obtain a report from your vendor or vendors showing each deferral deposit by date
3. Compare the totals to the amount on your W-3′s, box 12a: deferral compensation
4. If the totals do not agree, research each pay period to locate any participants who received more or less than the amount withheld from their pay, as shown on their W-2s

Following is an example of how the schedule looks for a company with monthly payroll, and only one Form W-3:

As you can see, the deferrals by pay period agree with the total on the W-3, but the total deferrals withheld from these employees exceed the amounts deposited by $400. At this moment, it would be very important for this employer to identify what employee(s) did not receive an accurate allocation, and correct the mistake by immediately depositing the missed amount plus earnings. Needless to say, this is a reconciliation that should be performed after each payroll date, rather than just once a year. In no event should plan sponsors neglect to ensure the completeness and accuracy of their deferral deposits, just because they know that their auditor will do it. Plan sponsors’  internal controls must operate independently of the audit process to properly prevent and detect errors in plan operations.

Many plan officials have never heard of the ”Form W-3-Transmittal of Wage and Tax Statements,” because their payroll provider files the original Form W-3 with the government, as required, and gives them a pro-forma report containing payroll totals for the year. On the W-3, the crucial piece of information for the reconciliation of deferrals withheld to deferrals deposited is on Box 12a: Deferred Compensation. The total payroll page from your payroll provider will definitely show total 401(k) or 403(b) plan deferral withholdings for the year, and it will show even more payroll information than the W-3. Much of that information will be essential to produce an accurate census, the next step after the deferral deposit reconciliation. Just like fitness training is never done, plan operations and their administrative oversight is never done either.

Lastly, please note that this employer remitted the deposits within seven days after each payroll date, thereby complying with the Timeliness of Deposits rules available to small plans as a safe harbor. Large plans must deposit deferral withholdings as soon as they can be reasonably segregated from plan assets, but in no event later than the 15th business day of the month following the month of withholding. The DOL has stated that timeliness of deposits is a case-by-case determination, and that the 15th business day of the following month was never intended to be a safe harbor. Deferral deposits are no place to lose the race. Since the DOL analyzes patterns of deposits for their subjective determination of reasonableness, steady patterns of 3 to 5 days may be a better choice than erratic patterns of immediate deposits followed by longer time lags.  Just as in distance running, sometimes steady wins the race.

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Posted by Stacey Snyder

As explained in Timeliness of Deposits, the Department of Labor (DOL) has set deadlines for which salary deferrals must be deposited into the plan. If these deadlines are not met, a prohibited transaction under Section 4975 will have occurred and Form 5330 must be filed and excise taxes paid for each year or part of the year that the prohibited transaction is outstanding.

The purpose of Form 5330 is to calculate and pay excise taxes on failures related to employee benefit plans. When Form 5330 is filed because prohibited transaction has occurred under Section 4975, the amount of excise tax is equal to 15% of the amount involved. In the case of late deposits, the amount involved is based on interest on the late deposits because the late deposits are treated as a loan to the employer.

The interest is calculated by multiplying the amount of deferrals withheld by the interest rate for underpayments of tax set by the Internal Revenue Service (IRS), which is currently 5%; prorated for the number of days the deposit was late.  For example, if deferrals totaling $25,000 were deposited 30 days late, your formula for calculating interest would be: $25,000*5%*(30/365) = $103. However, let’s say the deferrals of $25,000 were withheld in November or December and deposited 50 days late – 30 days during year 1 and 20 days during year 2. The interest calculated for year 1 ($103) should be added to the original amount of deferrals when calculating year 2 interest: $25,103*5%*(20/365) = $69. Additionally, year 1 interest must be added to year 2 interest when determining the excise tax due for year 2. Therefore, the total excise tax due based on the example above is $41: Year 1 excise tax ($103*15%) + Year 2 Excise Tax (($103+$69)*15%).

Each late deposit should be reported on Schedule C of Form 5330, which must filed by the end of the 7^th month following the plan’s year end and can be extended for 3 ½ months. Additional interest and penalties will be assessed on the amount of tax due if the form is not filed on time.

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Posted by Maria T. Hurd, CPA

In a time when nonprofit organizations are facing higher demand for their services with fewer financial resources available to them, maintaining compliance with the ever-changing landscape of regulatory requirements is becoming increasingly difficult. As a result, it’s no surprise that we are seeing more and more organizations fall victim to noncompliance with DOL regulations regarding retirement plan audits.

Every year, we become aware of at least one organization that needs several years of plan audits because the participant count was not performed accurately. Inevitably, a plan official or service provider failed to count a group of participants that they did not THINK should be included. Unfortunately, the participant count is not a matter of opinion. For a defined contribution retirement plan, such as a 401(k) or a 403(b) plan, the rules are clear.  The number of participants reported on the Form 5500 must include:

1-Any employee who is ELIGIBLE to participate in the plan, regardless of actual participation

and

2-Terminated or retired employees who have left their account balance in the plan

In many cases, the preparer of the Form 5500 erroneously counts only participants whose accounts were allocated a contribution during the year, or participants who have account balances. Both methods are incorrect and result in an inaccurate participant count. In many cases, the understated participant count results in a small plan filing, when the plan is actually a large plan that would have been required to attach audited financial statements for the plan to the Form 5500.

Plan officials who annually submit census information to the plan’s third-party administrator should ensure that all employees are listed, including employees that are not yet eligible, and employees who are eligible but not participating. A good way to verify the completeness of the census information is to reconcile the number of employees listed on the census with the number of W-2s and/or K-1s. Reporting all employees is especially important for 403(b) plan sponsors such as schools, which may have a substantial number of employees who are eligible due to the universal availability rules, but who do not choose to make any elective contributions to the plan. Universal availability rules for 403(b) plans are discussed in my previous entry,  403b Plans: Universal Availability Exclusions.

After ensuring that all employees are listed in the census, plan officials must make sure they submit a list of participants who have separated from service due to termination of employment, retirement, disability, or death, but still have an account balance in the plan. Once an accurate participant count is achieved, plan sponsors can refer to our previous blog I don’t want to grow up, I want to be a small plan, to determine whether prior small plan filings need to be amended to attach a financial statement audit. If so, our blog archive includes several entries to assist with the selection of a qualified retirement plan auditor.

Contrary to popular belief, counting participants is not as easy as 1,2,3, but with practice, the process becomes much more intuitive and plan sponsors can file accurate Form 5500 information returns before learning the hard way as a result of an IRS or a DOL audit.

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