Navigating DOL 401(k) Audit Red Flags

Think there’s no way your retirement plan might be audited? Think again.

The Department of Labor (DOL) can select any size retirement plan for a random 401(k) audit. Your plan also could face an audit if it matches an Internal Revenue Service (IRS) dataset targeting certain types of plans or if the plan raises a “red flag.”

What are the red flags? Here are a few things you can do to avoid or lessen your chances of being audited and increase your chances of surviving an audit.

Unhappy Employees

Most DOL 401(k) audits are triggered by complaints from current and former employees. One way to head off formal complaints is to respond to employees’ inquiries in a timely fashion. Keep copies of all correspondence.

If an employee makes a formal claim of benefits, follow the Employee Retirement Income Security Act (ERISA) regulations. Check with your ERISA attorney any time you issue a claim denial to ensure it is consistent with the written plan terms. Also, make sure that you clearly explain the participant’s appeal rights and the reason for the denial.

It’s not unusual for employees to become frustrated because they don’t understand the benefit plan. Regular training sessions can reduce these misunderstandings.

Problems with Form 5500

The second most frequent trigger for a DOL 401(k) audit is mistakes made when filing Form 5500 each year. Frequent errors include:

•    Forgetting to file.

•    Failing to file on time.

•    Not including all required schedules.

•    Failing to answer multiple-part questions.

•    Answering “no” to whether the plan is protected by an ERISA bond. If you don’t have a bond, you may be able to obtain retroactive coverage.

•    Having a bond that is less than 10 percent of the plan assets at the beginning of the year (plans with certain types of investments need higher than 10 percent coverage).

•    Your asset values at the end of the prior year don’t match your opening year balance for the succeeding year.

•    Having several alternative investments such as hedge funds or holding large amounts of cash not invested.

•    Not submitting participants’ 401(k) contributions to the trustee within a reasonable time. Although reasonable is not defined, most large companies deposit the money within a couple of business days. At the very least you should make the deposit no later than the 15th business day of the month following the day you withhold funds from the employee’s wages. Participants will notice if it takes a long time for their payroll deductions to be deposited in the fund, and this is one reason they might report you to the DOL. If you are late with the deposit or forgot to make it at all, there are procedures you can to follow. Call your benefits attorney for advice.

•    Forgetting to make a distribution to retirees. A minimum distribution of the account balance must be made to those who retire or who reach age 70½. Depending on your plan, you might have to make a distribution a year after an employee turns 70½ – even if that person hasn’t retired. However, it’s OK if you’ve made a reasonable effort to find the employee but couldn’t.

Experts recommend you pay a reliable third-party administrator, such as an accountant, to file your plan’s Form 5500 to make sure the compliance questions are answered correctly.

•    Using a Plan Document That is Out of Date – A plan document is a formal document detailing the type of plan and investment tools you’re offering employees, as well as participation requirements and guidelines. In short, it serves as the operating manual for the plan. Follow the plan closely, and don’t forget to update it if you change any rules or requirements.

•    Improperly Maintained or Inaccurate Records –The plan document spells out employees’ rights to retirement benefits and the formulas for determining them based on service or age requirements. If these are incorrect, an employee’s benefit calculation might be incorrect.

•    Making Improper Loans or Withdrawals – Plan documents list the specific reasons employees can take out hardship distributions. Anything not listed in the plan document is not allowed. Check to confirm the distributions reflect what is allowed.

•    Failing to Perform Nondiscrimination Testing – ERISA requires plan sponsors to perform discrimination testing to prevent favoritism for highly compensated employees. If you find errors, you must correct them. The record keeper or the third party administrator usually performs the test.

Additional Precautions

In addition to avoiding mistakes, make sure you have all of the documents needed to provide to the IRS or DOL. These documents include executed plan documents, participant notices and fiduciary policies.

Anticipate any problems by performing a self-audit and correct any issues before the IRS or DOL come calling.

For help or additional advice about your firm’s 401(k) program, please contact us.