Self-Audits

Posted by Chris Ciminera, CPA, QKA

Self Audits - Delaware 401k AuditsLet’s face it, humans make mistakes. John Wooden said “If you’re not making mistakes, then you’re not doing anything.” In my blog titled “Internal Controls in a Retirement Plan,” I pointed out the importance of controls at the plan sponsor and its service providers to help prevent mistakes in plan administration, help prevent fraud within the plan, and help the plan stay in compliance with laws and regulations. With strong controls in place, plan errors and fraud are less likely to take place. However, even with strong controls in place, mistakes can happen.  How can a plan sponsor find and fix these mistakes before the Internal Revenue Service or Department of Labor find them on audit?  The answer is to conduct an internal self-audit every year. In this blog, I will discuss the benefits of conducting a self-audit, high-risk areas to focus on, and provide some first steps to get you started.

Benefits of Conducting a Self-Audit

So before I begin, you may be asking yourself – “Why should I take time and resources out of my busy schedule to conduct a self-audit?” That is a good question, because the benefit should outweigh the cost of doing this self-audit.  Mistakes are costly. The following three items demonstrate the high cost of waiting for a regulatory audit or investigation to find the error. And the last bullet describes the fairly limited cost of a self-audit once procedures are in place.

  • Finding and correcting an error that affects a participant as early as possible will generally keep the cost of the correction down. For example, if you miss a deposit of a deferral that was withheld from payroll, the corrective contribution must include earnings. As a result, the earlier an error is caught, the less lost earnings will have to be provided by the plan sponsor.
  • Correction methods under the IRS Employee Plans Compliance Resolution System (EPCRS) get costly as you move up the correction scale. Self-correction is the first way to correct certain mistakes and the cheapest way to correct an error, but self-correction is not available for significant errors after two years. Additionally, many errors cannot be self-corrected if they are found during an IRS audit, and then the associated sanctions can become costly.
  • A self-audit actually shouldn’t cost you as much in time or resources as you might think. Initially setting up the process may take a little more time, but as a process is documented and continually implemented, it becomes an easy habit.

So now that you know some of the benefits of conducting a self-audit, let’s continue with risk areas to consider.

Risk Areas to Focus Your Self-Audit

There are certain mistakes that we tend to see on audit and that regulatory authorities say cause the most compliance issues. To manage your resources wisely, consider focusing on the following high-risk areas.

  1. Timeliness of Deposits

One of the most frequent errors we have found in auditing new clients is the timeliness of deposits of payroll deferrals. The main reason I find that plan sponsors aren’t depositing deferrals timely is that they just aren’t aware of the issue. Once plan sponsors know it is an issue, we generally see this fixed in subsequent audits.

  1. Not Following Plan Provisions

Another major area of audit errors that the provisions in the plan document are not followed. The main reason I find that this error occurs is that either the plan officials, such as the payroll and/or the human resources manager, is not reviewing the plan document before implementing procedures that are not compliant with the plan provisions. There are three areas in which plan provisions are often overlooked, which are:

  • the definition of compensation,
  • participant loan processing, and
  • hardship distributions
  1. Over-Reliance on Service Providers

One other risk area that we usually see is relying on a service provider to perform administration without any plan sponsor involvement.

Processes in a Self-Audit

So you may be asking yourself now, how do we catch our mistakes?  Some of our retirement plan audit procedures include:

  • summarizing the provisions of the plan document that will be tested,
  • performing walkthroughs of transactions to verify that control processes are taking place,
  • obtaining a W-3 and tying total deferrals withheld from payroll to total contributions deposited to the trust, and
  • selecting samples of employees and recalculating deferrals and employer contributions based on eligible wages and elected deferral amounts.

All of these are tests that you can perform internally during the year, especially if your plan is small and does not need a plan audit. In a self-audit, the important steps to find mistakes are:

  • Obtain a copy of the plan document, read it and summarize the important operational provisions. Both the payroll and the human resources personnel should print out the plan document, highlight important areas, make notes, etc. You can’t audit something without knowing what you are auditing and what provisions must be followed.
  • Review administrative processes in place to implement the plan provisions. Make a chart showing each employee that performs each function in administering the plan. Are there reviews in place or other controls that I listed in my Internal Control blog?  If yes, summarize them in a control document. Performing walk-through of your own processes while comparing the results to the plan provisions will help detect any plan provisions not being followed.
  • Trace deferrals withheld per the W-3 and participants’ W-2s to the deposit to the trust and the allocation to participant accounts. All deferrals withheld should be deposited completely and allocated accurately to the participants’ accounts. If the two don’t agree, then you will have to go back and find which participants and/or payrolls have an error.
  • Pick a sample of employees and recalculate the annual deferral amount by taking the eligible plan compensation and multiplying by the deferral withholding elections made by the participant, or apply the fixed dollar amounts elected to each payroll period. Some of the employees selected should be newly eligible employees.

If you do all of these steps in your self-audit, document it in an Excel spreadsheet and save the information in the retirement plan file. If you ever do get audited you can show the IRS or DOL the steps you performed and this will show them you are trying to do everything you can to ensure compliance. If a mistake does slip by the controls in place and self-audit review, and the mistake is subsequently caught on audit or investigation, then you can show the DOL or IRS the effort you made in trying to comply. These efforts will be beneficial in helping reduce sanctions that may be imposed.

These are not the only steps you can take. Feel free to contact us if you would like to discuss further procedures for a self-audit.

In the end, we all make mistakes. But as George Bernard Shaw said, “A life spent making mistakes is not only more honorable, but more useful than a life spent doing nothing.”  Although mistakes may happen in retirement plan administration, not doing anything to find them will only cause more headaches in the future.

Photo by Marco Verch (License)

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