The word "audit" rarely brings to mind thoughts
of pleasure, ecstasy, or even mild joy. On the other hand, an audit
"waiver" might cause any one of these emotions, and understandably so.
Because an audit waiver means that no audit will be necessary, and from
a plan sponsor's perspective, that's a good thing.
The audit being referred to here is not the typical one done by an
IRS agent. It's the audit required to be performed each year by an
independent public accountant of a qualified retirement plan, which must
be attached to the annual return filed with the Department of Labor
Up to now plans with less than 100 participants ("small plans") were
automatically exempt from this audit requirement. Under final
regulations issued last year by the Department of Labor, such plans may
still be exempt from having the accountant's audit done. However, to
have this requirement waived, small plans will now have to take some
This newsletter will examine the new small plan audit rules and
explain how plan sponsors can continue to be exempt.
New Rules to Safeguard Small Pension Plan Assets
The new measures reveal a desire to increase scrutiny of small plans.
This was prompted in part by a particularly egregious case of
misappropriation of assets of a small pension plan over several years
that gained national attention. Another factor was the dramatic increase
in small retirement plan assets over the past 25 years.
Consideration was given to the idea of having all plans comply with
the audit requirements. However, in issuing the final regulations, the
Department of Labor attempted to "balance the interest in providing
secure retirement savings for participants and beneficiaries with the
interest in minimizing costs and burdens on small pension plans and the
sponsors of those plans."
What is an Accountant's Audit?
There are two types of audits that a qualified independent accountant
may have to perform if the plan is not exempt from the requirement.
One is a "limited scope" audit which is applicable where the plan
assets are held by a bank, trust company or other such institution. It
includes a review of the investment statements, the trustee's internal
controls, employee eligibility, participant data and plan distributions.
In 401(k) plans, confirmation of participant data typically includes
deferral elections and individual account investment elections.
A "full-scope" audit is required where the assets are held by an
individual trustee. In that case the auditor must confirm the existence
of the plan investments, such as by viewing actual stock and bond
What is a "Large Plan"?
Any plan that has 100 or more participants at the beginning of the
plan year is considered a large plan, and must file an accountant's
audit report with form 5500. In a 401(k) plan, the term "participant"
includes any employee who is eligible to defer a portion of his
compensation into the plan, whether or not he actually does defer or
otherwise receives a contribution allocation.
Where the number of participants is between 80 and 120 and an annual
report was filed last year, the plan administrator may elect to treat
the plan in the same manner as the previous year, even though the
current participant count would otherwise put it in a different
Example: The annual report filed for 1999 reflected a total
participant count as of the beginning of the year of 90. The plan was
thus considered a "small plan" exempt from the audit requirement. In
2000, the plan had 105 total participants as of January 1. The plan
would normally be considered a large plan for 2000, but the
administrator may elect small plan status since the participant count
does not exceed 120 and it had small plan status last year.
In the same manner, an administrator could elect large plan status if
the participant count dropped from 110 last year to 95 this year,
although there isn't much incentive to make that election.
New Small Plan Exemption Requirements
Previously, small plans were automatically exempt from the audit
requirement. Under the new rules, the requirement is waived for small
plans for each year the following conditions are met:
At least 95% of the assets of the plan constitute "qualifying plan
assets" (defined below), or any person who handles plan assets that do
not constitute qualifying plan assets is bonded in accordance with
section 412 of ERISA for the amount of such non-qualifying assets.
The Summary Annual Report, required to be provided to plan
participants each year, includes additional information (detailed
The administrator makes available for examination, or furnishes
copies, free of charge, to any participant or beneficiary who requests
a statement from any regulated financial institution or evidence of
any bond required by this regulation.
Qualifying Plan Assets
If at least 95% of plan assets are "qualifying plan assets," the plan
need not obtain additional bonding. For this purpose, qualifying plan
assets are defined as any of the following:
Qualifying employer securities as defined in ERISA section
Any participant loan meeting the requirements of section 408(b)(1)
Assets held by any of the following institutions:
Bank or similar financial institution
A registered broker-dealer
Any other organization authorized to act as trustee for
individual retirement accounts under Internal Revenue Code section
Shares issued by a registered investment company such as a mutual
Investment and annuity contracts issued by an insurance company.
Assets in individual accounts of participants or beneficiaries
over which the participants or beneficiaries have the opportunity to
exercise control and where statements from a registered financial
institution of such assets are furnished at least annually to the
participants or beneficiaries.
Example: A retirement plan has 60% of its assets invested in
mutual funds, 20% in bank certificates of deposit, 17% in annuity
contracts and 3% in real estate limited partnerships. Since 97% of the
assets are considered qualifying plan assets, the plan would not be
subject to the additional bonding requirement.
The determination as to the percentage of plan assets that constitute
qualifying plan assets is generally made as of the first day of the plan
year. Special rules apply, based on estimates, for the initial plan
Additional Summary Annual Report
The plan administrator is required to file an annual report (form
5500) each year with the Department of Labor. A summary of form 5500,
called the Summary Annual Report, must be provided to each plan
participant and beneficiary. Small plans will now have to include the
following additional information in the Summary Annual Report in order
to be exempt from the audit rules:
The name of each regulated financial institution holding or
issuing qualifying plan assets and the amount of such assets reported
by the institution as of the end of the plan year. However, this does
not include employer securities, participant loans that satisfy ERISA
section 408(b)(1) and participant-directed individual accounts.
The name of the surety company issuing the bond, if more than 5%
of plan assets are non-qualifying assets.
A notice indicating that participants and beneficiaries may, upon
request and without charge, examine or receive copies of:
Evidence of the required bond, and
Statements received from the regulated financial institutions
describing the qualifying plan assets.
A notice stating that participants and beneficiaries should
contact the Regional Office of the U.S. Department of Labor's Pension
and Welfare Benefits Administration if they are unable to examine or
obtain copies of the regulated financial institution statements or
evidence of the required bond, if applicable.
All qualified plans subject to ERISA are required to have a surety
bond in the amount of at least 10% of plan assets. The bond provides
protection to the plan against loss by reason of acts of fraud or
dishonesty on the part of the plan administrator, officer or employee.
Where the new small plan audit rules require that a bond be obtained,
it need not be in addition to this long-standing 10% bonding
requirement. The 10% bond may be enough to satisfy the audit exemption
bonding requirement, or an additional bond may need to be purchased to
make up the difference.
Example: A plan has 92% of its assets in qualifying plan
assets. Since this amount is less than the required 95%, a bond is
required for 8% of the plan assets. But since the plan already has a 10%
surety bond, no additional bond must be obtained.
If the plan had only 85% of its assets in qualifying plan assets, an
additional bond for 5% of plan assets would be needed.
The new regulations are effective for plan years beginning after
April 17, 2001. For calendar year plans, the first plan year the
regulations will take effect will be 2002.
The Department of Labor has added new bonding and reporting
requirements for small plans that wish to be exempt from the annual
audit by an independent public accountant. The purpose of the new rules
is to provide additional protection for participants of small plans,
which make up a significant portion of the overall retirement savings
vehicles in this country, with over $300 billion in assets.
Many small plan sponsors will be able to meet the new standards by
providing additional information in the Summary Annual Report, and by
making certain documents available upon request. Some sponsors will also
have to increase their surety bond coverage. But these additional
inconveniences are minor compared to the additional cost and burden of
having to file an accountant's audit report each year. Plan sponsors who
do not comply with the new requirements will be responsible for filing
the audit report. In that regard, complying with the new standards seems
like a small price to pay.
The information contained in
this newsletter is intended to provide general information on matters of
interest in the area of qualified retirement plans and is provided with
the understanding that our company is not engaged in rendering legal or
tax advice. Legal or tax questions should always be referred to a qualified tax advisor such as an attorney or CPA.