Posted by Maria T. Hurd, CPA, RPA
Large Plans Require Financial Statement Audits
Generally, plans with at least 100 participants on the first day of the plan year must engage an independent qualified public accountant to perform an audit of the plan’s financial statements. The audit report, financial statements, note disclosures, and supplementary schedules are filed as an attachment to the plan’s Form 5500 filing. A transitional election is available that allows growing plans to postpone the audit if the participant count is between 80-120 on the first day of the plan year, and the sponsor elects to continue filing a Form 5500 for the same size plan as they did in the previous year. Needless to say, plan sponsors wish to stay forever small, so they use the 80-120 exception to file as a small plan, to postpone the audit as long as possible, but they don’t typically use the 80-120 exception to continue filing as a large plan once the number of participants is 99 or lower. In general, small plans do not need to be audited and large plans must be audited. Exceptions to that simple general rule are beyond the scope of this discussion.
Having an Account Doesn’t Count, Until You Terminate
Employees’ eligibility to participate in a retirement plan, regardless of their actual participation in the plan, causes them to be counted as participants for purposes of determining whether the plan needs an audit. Actual participation in the form of contributions is not necessary. Eligibility to contribute, not an account balance, is what is considered for active participants, until they terminate employment. Terminated participants who still have a balance in the plan are also counted for inclusion in the total number of participants reported on lines 5 and 6 of the Form 5500.
Is Eligible but Separate a Better Answer?
In the past, industries with high turnover would keep transient employees out of the plan by requiring a minimum of 1,000 hours and twelve months of service to become eligible. That is all about to change; the SECURE Act will require employers to permit part-time employees who work at least 500 hours per year for three consecutive years to participate in 401(k) plans and make elective deferrals. No employer contribution will be required for these participants. Industries like landscaping, home care, car washes, and restaurants will find themselves having to count long-term, part-time employees as participants, even if they don’t have an account balance. The numerous newly-eligible participants could cause the plan to become a large plan that requires a financial statement audit. In some cases, the audit cost will be charged to participant account balances. Despite the administrative complexities involved, some plan sponsors will consider sponsoring two separate plans if it helps them avoid the unwanted financial statement audit.
There Must be a Better Way
Fortunately, we have approximately four years until the first long-term, part-time employees become eligible in 2024 (we start counting the three consecutive years in 2021), which gives industry organizations like the American Retirement Association (ARA) an opportunity to request changes and guidance to turn the beat around. In an effort to spare the large plans with few account balances the cost of an audit, or the headache of sponsoring two plans, the ARA has requested that the DOL modify the rules for counting employees to exclude participants who are eligible solely because of the long-term, part-time employee rules of the SECURE Act or, alternatively, all participants who do not have an account balance. Absent a change in the definition of participant for reporting and disclosure purposes, the only available way to avoid a financial statement audit may be to keep long-term, part-time employees at arm’s length, in their own plan, like living in the same house but on different floors…..together, but apart.