Most 401k Plans must file some version of a Form 5500 annually. This form provides information to both the federal government as well as plan participants. In February 2023, the U.S. Department of Labor and the IRS announced changes to the Form 5500 under the requirements of ERISA (Employment Retirement Income Security Act) section 103(a)(3)(C). The changes took place in 2023 and are in effect for filings beginning July 2024 (See Fact Sheet). The changes to Form 5500 allow for improved reporting and oversight of all types of plans including multiple-employer plans (MEPs) and pooled employer plans (PEPs). Another big change is in the counting methodology used to determine a “small” plan and the eligibility for simplified reporting options available to small plans including the waiver of an audit. So, does your 401k plan require an audit?
Prior to the change, the need for an audit was based on “eligible” employees. Now, it is based on participants with an account balance. It might not sound like much of a difference, but for some it is. The definition of eligibility can be found in your specific plan documents. There may be an age requirement, a years of service requirement, a minimum number of hours requirement, or other requirements laid out in the plan. It is possible that an employee would be eligible but chose not to participate in the plan. They would still be counted in the total when determining the plan filing status.
Under ERISA Section 103, plans with 100 or more participants (previously eligible employees) at the beginning of the plan year are considered “large” plans and are required to have a plan audit performed by an independent CPA and file Form 5500. Plans with fewer than 100 participants (previously eligible employees) at the beginning of the plan year are considered “small” plans and are eligible for a waiver. Once you file as a large plan, you will always have to file as a large plan even if the number of eligible employees dropped below 100. However, with the change, there is an opportunity for a once large plan to revert back to a small plan since the count is now based only on participants with account balances and not all eligible employees. The “80-120 rule” still applies and allows a plan that filed as a small plan to continue to follow small plan requirements until it reaches 121 participants.
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Requirements followed for the previous year Form 5500
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# of participants at the beginning of the current year
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Requirements to be followed for the current year Form 5500
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Small plan
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80-99
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Small plan
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Small plan
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100-120
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May elect to file again as a small plan or switch to a large plan
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Small plan
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More than 120
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Large plan
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Large plan
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80-99
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May elect to file again as a large plan or switch to a small plan
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Large plan
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100-120
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Large plan
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Large plan
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More than 120
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Large plan
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For example, if, at the beginning of 2022, there were 150 eligible employees, but only 50 participants with balances, the plan would have been required to follow the large plan requirements (as the number was still based on eligible employees). In 2023, if there are 175 eligible employees and 55 participants at the beginning of the plan year, the plan would have still been required to follow large plan requirements under the old methodology. However, the plan would now follow small plan requirements since the number is based on actual participants. Even if there were up to 120 participants, the plan could still follow small plan requirements for 2023.
So why the change? Part of it is to alleviate the cost of an audit on small plans. The cost of a 401K audit depends on a number of factors but could range between $10,000 – $30,000. It has been estimated that the change could have a combined savings of as much as $95 million annually. There is also a hope that by lessening the compliance burden, more employers, particularly startups and growing companies, will offer 401K plans to their employees. In addition, changes to Form 5500 will improve the form as a public disclosure and data tool, especially for MEPs and PEPs.
While cost savings is a good thing, it also means the employer (plan sponsor) and plan administrator(s) have an even greater duty. In addition to their existing fiduciary responsibility to manage plan assets they will also need to ensure they have more than adequate internal controls and oversight to reduce the risk of error and noncompliance. A plan audit can still be a vital part of that oversight and there is nothing preventing a plan sponsor from having an audit to ensure compliance, it just would not be necessary to file the audit with Form 5500.
