By: Saul Jimenez
Retirement plan audits are often considered by employers to be an inconvenience and unwelcome expense. But if the participant count in your company’s plan reaches 100 or more on the first day of the plan year, an audit may be in your near future.
Calculating the participant count sounds simple, but it isn’t always just a matter of counting heads. The participant count is the key factor that triggers the requirement for an audit, and getting the count right is a matter of compliance with federal regulations. Understanding who is considered a participant is critical to the process. Moreover, there are strategies for managing the participant count that can help a company avoid or delay the requirement for an audit.
Who is a Participant?
An accurate count of participants in your defined contribution retirement plan is critical in helping you meet regulatory requirements as a plan sponsor. Most notably, an accurate participant census determines whether your plan is subject to the annual audit requirement and has a significant effect on the plan’s annual non-discrimination testing results.
The U.S Department of Labor (DOL), which regulates workplace 401(k) and 403(b) plans, requires that the participant census be determined on the first day of the plan year, as defined in your plan documents. Most retirement plans use the calendar year as their plan years, but some organizations use their fiscal year dates. Be sure you know the date that your plan documents specify as the beginning of your plan year before determining the census. While the first day of the plan year is important for audit determination, accurate census information should be maintained throughout the year.
Your participant count is among the many data points reported to the DOL on your annual Form 5500. When filing the Form 5500, you must identify your organization as either a “large” plan or a “small” plan. The DOL defines large plans as those with 100 or more participants. These plans are required to have an annual independent plan audit. Plans with 99 or fewer participants are considered small plans and are not subject to the audit requirement.
But the DOL’s “80-120 rule” enables some organizations that have surpassed 100 participants to escape the audit requirement for one year. The 80-120 rule allows an organization to file its Form 5500 in the same size category it filed in the previous year. The rule applies to organizations that have between 80 and 120 participants. If a plan sponsor files as a small plan under the 80-120 rule, and then still has more than 100 participants the following year, it must file as a large plan – subject to the audit requirement – at that point. But the 80-120 rule gives growing businesses a one-year breather to concentrate on their operations. It also recognizes that the number of plan participants may fluctuate from one year to the next, so plans that crossed the 100 participant line one year and subsequently fell back to fewer participants needn’t be snared by the audit requirement.
The number of plan participants reported on your organization’s Form 5500 must include:
- All employees who are eligible to participate in your defined contribution plan, regardless of whether they are contributing to the plan.
- All former participants who still have account balances in the plan, regardless of the reasons they left the organization, and the size of the account balances.
- Deceased participants whose accounts contain a balance on census day (the first day of the plan year). This may occur when a participant has died, but the beneficiary of the account has not yet withdrawn the funds.
Let’s add up the numbers, using ABC Manufacturing as an example. ABC is a growing company with 81 employees, of whom 73 contribute to the company’s 401(k) plan. The company also has 15 former employees who still have account balances in the plan, and 11 retirees who are receiving distributions from their accounts in the plan. ABC expects to fill three machinist positions in the next month and hire five new employees in the marketing and finance departments.
Adding up the numbers, ABC Manufacturing has 107 participants in its 401(k) plan, since all employees are considered participants whether or not they actively contribute, and the former employees and retirees push the census up even further.
This is the first year ABC has exceeded the large plan threshold, yet it still has fewer than 120 participants so it will not be required to have an audit. However, ABC’s management wants to avoid the cost and compliance requirements of an audit next year, meaning the company must strategically manage its participant count to forestall the audit requirement for at least one year and possibly longer.
Managing Your Participant Count
The primary goal of managing the participant count is to reduce it as much as possible while remaining in compliance with ERISA (Employee Retirement Income Security Act of 1974) law and regulations.
For ABC Manufacturing, this would mean encouraging former employees and retirees to remove their savings from the company’s plan upon separation by rolling the balances over into IRAs or 401(k) plans at their new places of employment. If all the separated participants complied, ABC’s count would come down to the 81 current employees, giving the company at least one more year and possibly more to file its Form 5500 as a small plan.
To manage your plan’s participant count, consider these strategies:
- Communicate with all separated employees with vested account balances at least annually about the importance of managing their own retirement portfolios.
- Encourage former employees and retirees to roll over their balances into an IRA or into the 401(k) at their new employer.
- Communicate with all separated participants with vested account balances at least annually concerning required tax notices and distribution request forms or online requests to process a payment.
- Maintain plan documents that allow for lump-sum distributions.
- Maintain plan documents that allow for “cash-outs” for vested balances below a certain level.
Contact your KRD advisor to discuss how your company can improve communication with plan participants and strategically manage your plan’s census.
