Disclaimer of Opinion Removal Analysis

Co-Authored by Maria Hurd, CPA and Tyler Starr, CPA

403(b) Plans: Has the Time Come to Eliminate the Disclaimer of an Audit Opinion?

Fifteen years have passed since 403(b) plans became subject to the same financial reporting and disclosure requirements as 401(k) audits. Auditors have been disclaiming their audit opinion on account of the financial statements potentially missing permissibly excluded contracts. Is it time to consider whether there is a continuing risk that the financial statements are potentially missing assets?

Background: 2009 Financial Statements Required, Audit Requirement, and DOL Enforcement Relief

• The Wild, Wild West: Prior to 2009, 403(b) plans were not required to have financial statements. Annuity contracts in connection with the plan were issued directly to individuals, who could move the balances to other custodians without the employer’s involvement. Regardless of their location, the contracts were still legally connected to the 403(b) plan and required to follow the plan’s provisions, but plan sponsors had no control over where the plan assets went. It was the wild, wild west.
• The DOL Resolves to Rein it in: Starting with the 2009 plan year Form 5500 filings, ERISA-covered 403(b) plans were required to compile and present financial information. As a practical matter, compiling complete and accurate financial statements that included all the plan assets was impossible for many plans. Since 1958, when Congress made 403(b) plans available to 501(c)(3) organizations, participants had been able to move their individually-owned accounts to other custodians without the employer’s involvement. Plan sponsors had no way of knowing how to locate all the contracts that should be included in the plan’s statement of net assets. Plan sponsors did not know what they did not know.
• Disclaimer Audit Opinions Expected: With the requirement to include financial information on Form 5500 came an audit requirement for large plans. Plans with 100 or more eligible participants at the beginning of the plan year (and filing as a large plan) were required to have an annual audit of their financial statements. The AICPA explained that auditors cannot issue clean audit opinions for incomplete financial statements. When the amount of a misstatement cannot be quantified, auditors disclaim an audit opinion due to the absence or unavailability of sufficient appropriate audit evidence, or the existence of unreliable information. Disclaimer Opinions can cause the Form 5500 to be rejected, and rejected Forms 5500 can be treated as not filed, and subject to penalties.
• Regulatory Relief to the Rescue: In July 2009, the U.S. Department of Labor (DOL) issued Field Assistance Bulletin (FAB) 2009-02. Under DOL FAB 2009-02, plan administrators could exclude pre-January 1, 2009 annuity contracts and custodial accounts for ERISA reporting purposes if they met the following four criteria:

1. 1. 1. The contract or account was issued to a current or former employee before January 1, 2009.
      2. The employer ceased making contributions (including employee salary reduction contributions) to the contract or account before January 1, 2009.
      3. All rights and benefits under the contract or account were legally enforceable against the insurer or custodian by the individual owner without employer involvement.
      4. The individual owner of the contract was fully vested in it.

BUT, permissibly excluding contracts did not mean that the financial statements were now complete and accurate. The AICPA still could not approve the issuance of clean opinions. The DOL’s Relief extended to Disclaimed Opinions, as follows:

• If a 403(b) plan administrator excludes such pre-2009 contracts and accounts, the DOL will not reject a Form 5500 based on a qualified, adverse, or disclaimed opinion solely due to this exclusion.
• Accountants can explicitly state that the reason for such an opinion was the non-inclusion of these contracts and accounts in the audit or financial statements. In February 2010, the DOL issued Field Assistance Bulletin (FAB) 2010-01 to supplement FAB 2009-02.

It Has Been 15 Years: Can the Disclaimer Be Removed Now?

Can a plan sponsor who did not know what it did not know in 2009, know enough in 2024 to know that the financial statements are not materially misstated? Maybe.

Analyzing demographics, plan trends, and national trends could allow the plan sponsor to conclude that any potentially missing accounts would have been distributed by now, losing their legal connection to the plan.

Below is an example using a plan sponsor with the following specifications:

• 200 employees,
• $12 million in assets,
• 50% participation rate as of 2009,
• average age of 48 as of 2009,
• 12% of terminated employees have account balances;
• average account balance as of 12/31/22 $59,000.

Average Age: In our example client, the 403(b) plan’s participants average age as of 2009 was 48, and every year thereafter, the average age has been between 46 and 49 years of age. Using the plan’s average age as of 2009, the plan sponsor could reasonably conclude that at least half the participants who terminated employment prior to 2009 have achieved retirement age and would have taken a distribution of their potentially unknown account, as shown by the plan-specific trend for participants who achieve retirement age.

On a national level, the Employee Benefit Research Institute’s examination of job terminations from 2008 to 2017 shows that only 22 percent of people ages 60 or older kept their entire balance in the plan. The potentially unknown accounts are not represented in any published benchmarking statistics.

Based on the plan’s trends for participants with account balances who achieve retirement age, coupled with national statistics, a plan sponsor could conclude that over half the potentially unknown accounts as of 2009 would belong to participants who have achieved retirement age and would have been distributed as of 2023.

Participation Rate: Based on our imaginary plan’s actual participation rates on the years 2009 and 2010, the plan sponsor could reasonably conclude that the participation rate of employees who terminated employment prior to 2009 was consistent with actual participation rates of the plan.

For example, if the plan’s participation rate was about 50% in 2009, a plan sponsor could reasonably conclude that half of the employees who terminated employment before 2009 did not have an account balance through the plan and consequently, do not have a potentially unknown account.

On a national level, EBRI shows that 48% of private industry workers participated in a defined contribution (DC) plan in 2022. This 48% current national participation rate reflects all the recent automatic enrollment efforts, such that our sample employer’s conclusion that participation rate for potentially unknown accounts was 50%, based on the plan’s experience, seems reasonable and conservative.

In our example, half of the pre-2009 participants would have likely achieved retirement age by 2024, and half of the participants who were under 50 years of age as of 2009, would not have had an account under the plan, based on a 50% participation rate. That leaves 25% of terminated participants who are not yet retirement age and who potentially transferred their account balances to another custodian without the employer’s knowledge.

National studies show that employees are more likely to save for retirement through a payroll deduction mechanism provided by the employer than they are likely to save on their own. Additionally, studies have proven that most participants have inertia and would not be likely to take the initiative to make choices other than those offered by the ones established through their employer-sponsored plan. Subject to verification with remaining employees who were hired prior to 2009, our sample employer would take the position that the only potentially unknown accounts would belong to employees who terminated prior to 2009, when the 403(b) plan’s books and records were created.

Distribution Rates: To estimate how many of the remaining 25% of employees terminated prior to 2009 would still have an unknown account, the plan sponsor would likely consider both, the plan’s distribution rates, as well as national averages regarding both, the likelihood that employees would seek investment products outside of the payroll deduction savings mechanism provided by the employer, and the likelihood that they wouldn’t have already distributed amounts transferred out of the provided 403(b) plan custodian.

Based upon coverage-gap studies performed by the Center for Retirement Research (CRR), the plan sponsor in our example could reasonably conclude that the remaining 25% of employees who terminated prior to 2009 are not likely to have a potentially unknown balance because they are not likely to have moved their 403(b) balance to a custodian other than the default entity provided by the plan. Additionally, our sample employer’s plan demographics show that only 12% of the plan’s accounts belong to terminated participants. The owners of the potentially unknown accounts are, by definition, terminated employees. In a plan with 200 unknown account balances, this would mean that, at most, one or two people could have unknown accounts, but it seems unlikely that there would be as many unknown account balances as there are known balances currently in the plan. Two missing balances seems to be a very conservative estimate.

Estimates…..most financial statements include estimates. Can the plan sponsor reasonably estimate that two potentially missing account balances would not materially misstate the financial statements? Not with 100% certainty. One person with a substantial account balance could change the result….One Mr. Mystery McRich who has not taken a distribution of his unknown account could make the financial statements materially misstated. Is Mr. Mystery McRich likely to exist?

Average Account Balances: In our example plan sponsor, the average account balance is $59,000. Nationally, at year-end 2022, participants in their forties with more than two to five years of tenure had an average plan account balance of about $38,000, compared with an average plan account balance of about $312,000 among participants in their sixties with more than 30 years of tenure. Participants in our example plan with 2-5 years of experience, in their forties, had an average account balance of $11,000 at 12/31/21. Participants in our example plan with more than 30 years of tenure had an average account balance of $109,000 as of 12/31/22. Having $150,000 in account balances not reflected in the financial statements would be one percent or less for a plan with assets of $15,000,000 or more. Arguably, this 1% understatement would not constitute a material misstatement.

Certainty vs Reasonableness: As explained at the beginning of this article, the reason for the disclaimed audit opinions is that the amount of assets that is potentially missing from the financial statements cannot be quantified. The purpose of this analysis is to determine whether plan sponsors can now reasonably estimate that their financial statements are complete and accurate in all material respects.

In life, nothing is certain except for death and taxes. Speaking of death, based on the actuarial tables, most people who were plan participants in our sample plan in 2009 will be retired or deceased in another fifteen years. No question. But do plan sponsors have to wait that long to remove the disclaimer, or are reasonable estimates and assumptions a way to do it now? It depends on each plan’s facts and circumstances. As auditors, we cannot make management decisions, but we can assess the reasonableness of a plan sponsor’s analysis.

What if Rich Mystery Man Shows Up After the Disclaimer is Removed?

The audit standards address the auditor’s responsibilities relating to subsequently discovered facts that become known to the auditor after the date of the auditor’s report that, had they been known to the auditor at that date, may have caused management to revise the financial statements and/or the auditor to revise the auditor’s report. For purposes of this article, we will not discuss a situation in which management does not revise the financial statements to make them complete and accurate in all material respects.

If additional information and relevant additional procedures reveal that the financial statements for a previously audited plan year need to be adjusted by a material amount, the auditor will revise the previously expressed opinion, as needed, and disclose the following matters in an emphasis-of-matter or other-matter paragraph:

1. The date of the auditor’s previous report
2. The type of opinion previously expressed
3. The substantive reasons for the different opinion
4. That the auditor’s opinion on the revised financial statements is different from the auditor’s previous

When management revises the financial statements, the auditor will perform the audit procedures necessary for the revision. The auditor also should either:

1. date the auditor’s report as of a later date; extend the audit procedures to the new date of the auditor’s report on the revised financial statements; and request written representations from management as of the new date of the auditor’s report, or
2. include an additional date in the auditor’s report on the revised financial statements that is limited to the revision (that is, dualdate the auditor’s report for that revision), thereby indicating that the auditor’s procedures subsequent to the original date of the auditor’s report are limited solely to the revision of the financial statements described in the relevant note to the financial statements. In this circumstance, the auditor should request written representations from management as of the additional date in the auditor’s report about whether
   1. any information has come to management’s attention that would cause management to believe that any of the previous representations should be modified.
   2. any other events have occurred subsequent to the date of the financial statements that would require adjustment to, or disclosure in, those financial statements.

Needless to say, an amended Form 5500 will have to be filed.

Two Good Options

To remove the disclaimer or not to remove the disclaimer, that is the question. Plan sponsors should consider the risk at hand. If a reasonable choice to represent that the financials are complete and accurate in all material respects because it is not probable that material balances are unknown, and Mr. Mystery McRich shows up later, the plan sponsor will have to incur the administrative burden of updating the financials and pay the auditor to reissue several years of audit opinions. A disclaimer opinion for the next fifteen years until almost everyone is likely deceased or close to it is safer and guaranteed to be accepted by the DOL. New information would necessitate reissued financial statements, so the real question is, how much does the plan sponsor value a clean opinion, if obtaining one is a reasonable possibility.

The statute does not define “reasonable”, so when it comes to whether the disclaimer can and should be removed from a 403(b) plan, I can definitely say that it depends…maybe….but in any event, both the analysis and the conclusion should be reasonable!