Benefit Insights®

February 2001 Newsletter
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Small Plans Face New Audit Waiver Requirements

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 (form 5500).

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 additional steps.

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 certificates.

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 category.

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 below).
  • 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 407(d)(5).
  • Any participant loan meeting the requirements of section 408(b)(1) of ERISA.
  • Assets held by any of the following institutions:
    • Bank or similar financial institution
    • Insurance company
    • A registered broker-dealer
    • Any other organization authorized to act as trustee for individual retirement accounts under Internal Revenue Code section 408.
  • Shares issued by a registered investment company such as a mutual fund company.
  • 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 year.

Additional Summary Annual Report Information

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.

Bonding Requirement

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.

Effective Date

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.

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