Death by a Thousand Cuts?

Editor’s Note: This is the first in a two-part series about service providers’ audits of clients and their plans. 

That’s what a first financial audit can feel like, says an industry expert. But it doesn’t have to.

“Death by a thousand cuts. That’s what initial 401(k) and 403(b) audit clients fear their first financial statement audit will feel like,” writes Maria Hurd, Director of Accounting and Auditing at Belfint Lyons Shuman, in “Could I Fail my First 401(k)/403(b) Plan Financial Statement Audit?,” an analysis in the firm’s blog. 

But Hurd comes to the rescue, noting that fear of the unknown can evoke an expectation that the worst will happen. She offers some encouragement, remarking that while it is possible that one could fail an audit, it is not likely that will happen in the first one. 

Nonetheless, to err is human. Hurd shares her experience regarding what mistakes she has seen in the course of initial audits. 

Administrative Matters 

Auto Enrollment of Newly Eligible Employees. Hurd reports that during audits, her firm has encountered instances in which an employer had failed to automatically enroll all newly eligible employees into the plan as the plan document required, and there was no written documentation of employees opting out, which prevented corroborating that participants were not supposed to be automatically enrolled without alternative audit procedures. 

Participant Deferral Changes. There have been audits, Hurd says, when they found that plans lacked sufficient controls to ensure that changes to employee deferral elections are timely and accurately updated in the payroll system. 

Early or Late Entry into the Plan. There have been times, according to Hurd, when plans lacked controls sufficient to properly identify participant eligibility dates and the related entry dates as defined by plan provisions. 

Forfeiture Balances. Sometimes, plans lack procedural controls to ensure forfeited participant accounts are used by the end of the following year after the forfeitures are generated pursuant to plan provisions. 

Inconsistent Demographic Data. There sometimes are instances in which there are discrepancies between what the recordkeeping and payroll systems have shown; for instance: 

• payroll totals and totals on census data submitted for nondiscrimination testing that do not agree; and 
• hire dates, termination dates, and hours worked that are inconsistent or missing altogether. 

Compensation 

Eligible Compensation. Sometimes, Hurd says, the compensation used to calculate employee deferrals is not consistent with the definition of “eligible compensation” the plan document spells out. 

Contributions

Contribution Sources Are Incorrect. Hurd says that they had seen instances in which plans lacked controls to ensure contributions are remitted to the plan with accurate source type, including: 

• employer matches; 
• employer safe harbor nonelective contributions;
• pre-tax deferrals;
• profit sharing;
• QNEC;
• rollovers; and 
• Roth deferrals.

Incorrect Employer Match Calculation. There have been times in which their auditors have found matches calculated for each individual payroll, while the plan required an annual computation. 

Timely Remittance of Contributions. Hurd reports that there are plans that lack controls that would ensure that the employer segregates all employee contributions and loan repayments from its general assets as soon as administratively feasible—which the Department of Labor (DOL) requires. 

Distributions

Mandatory Distributions and Locating Missing Participants. Hurd says they have found terminated participant accounts that do not exceed $5,000 at year-end.
Incorrect Vesting Computations. Hurd’s firm has encountered instances in which participants received an incorrect distribution because vesting and forfeitures were calculated incorrectly. 

Incorrect Tax Withheld. Hurd says that in distribution tests, they have found that enough federal taxes had not been withheld from some participants; in addition, there were times in which there was no documentation supporting the assertion that a participant had directed that a lower amount of taxes be withheld.

Hardship Distributions Not Self-Certified or Substantiated. Hurd’s firm has found that plans did not maintain source documentation to support and corroborate hardship distributions.

Documentation 

No Documentation of Notification to Newly Eligible Employees. Sometimes, Hurd says, they found that plans did not maintain documentation showing that all newly eligible employees were timely notified of their ability to participate in the Plan. Alternative procedures were needed to corroborate that some sampled eligible employees who are not participating had opted out.

Documentation of Employee Elections. Hurd reports that there were occasions in which plan managers did not maintain documentation of enrollment and changes of election, which could put the plan sponsor at risk of corrections, fines, and penalties.

Documentation of Review of Plan Elements and Fiduciary Oversight. There were instances in which the firm’s auditors found that a plan had failed to maintain documentation showing there had been a review of the plan’s elements and fiduciary oversight. 

Loans

Untimely Loan Repayments. Their auditors identified instances of failure to set up timely repayments of loans to plan participants. 
Loan Repayments Deducted Past Payoff Date. There were times in which Hurd’s firm found insufficient controls to ensure loan repayment deductions stopped when the loan was paid off. 

Delinquent Participant Loans. Auditors found instances in which controls were insufficient to ensure that delinquent participant loans were monitored and deemed distributed at the end of the grace period the written loan policy specifies. 

And What if….

If an initial audit does discover a mistake, all is not lost, Hurd indicates—she reminds that the IRS has made the Employee Plan Compliance Resolution System (EPCRS) available so a taxpayer can correct a mistake themselves and thereby not only be in compliance but also avoid penalties. 

And if a taxpayer cannot use EPCRS, the IRS also has made the Voluntary Compliance Program (VCP) available. That method of correction is not free—there is a fee for submitting a VCP application—but nonetheless it offers a means to be in compliance. 

Next: To Err Is Human—to Correct, Divine