This is the first in a series of educational articles by Cerrado Group members.
A government audit of your retirement plan—Are you ready?
Any season is audit season. It can happen for any reason or no apparent reason at all. The process starts with an official letter from the Internal Revenue Service (IRS) or the U.S. Department of Labor (DOL), the two agencies with jurisdiction over qualified retirement plans. Most qualified retirement plans are either defined benefit or defined contribution, with 401(k), 403(b) and profit-sharing plans being the most common. Regardless of the plan type, they all comply with Section 401(a) of the U.S. tax code, which means that contributions are tax-deductible and accumulated investment income is tax-deferred.
Why all the fuss? The Investment Company Institute® reports that 401(k) plans currently hold an estimated $6.9 trillion in assets. In fact, defined benefit or defined contribution plans with private and public-sector employers represent nearly one-third of the $35.4 trillion U.S. retirement market. Those figures fail to calculate the value these plans hold for the millions of individuals who are trusting their financial future on their retirement plan’s fairness and solvency. The stakes are high.
Third-party administrators: Your new best friend
If anyone can turn the dread of an audit into a calm sense of confidence, its Robert Chin, President of Abacus Benefit Consultants, Inc.—one of the founding member firms of The Cerrado Group. “The appreciation for the world of value we deliver as third-party administrators skyrockets the moment one of our clients receives an audit notice,” Bob said. “Audits usually span a three-year period that includes the ‘current’ year as well as the year before and the year after. Right now, we are dealing with audits for 2018 that include 2017 and 2019. Auditors can request information that goes beyond those three years at their discretion, and anything they want or need must be provided.”
With a signed power of attorney in place, third-party administrators (TPAs) are able to represent a plan sponsor’s interests from the first IRS or DOL letter requesting information for a possible field audit. “TPAs can serve as knowledgeable intermediaries who are experienced enough to speak an auditor’s language,” Bob said. “We are familiar with the process and every form and document. We understand exactly what is needed and we know how to answer their questions. The first thing we do is invite the auditors to our office and let them know that we will provide any information they need from our client. Very often, the inquiry ends as soon as the specific requested documentation or verification is presented. If anything looks amiss or remains questionable, the next step is a field audit. But here again, we control the environment in our office and continue to represent the interests of both the plan employer and its employees. Our job is to make sure the audit goes well while the IRS or DOL lifts the hood and checks underneath to make sure the plan actually exists and that everything is being done correctly.”
What are retirement plan auditors looking for?
DOL audits ensure that plan participants are receiving all the promised benefits and that plan fiduciaries are acting in the plan’s best interests and not their own. Some specific areas of DOL interest include:
• Verify plan distributions, required employee notices, and beneficiary designations/consents
• Examine areas of potential participant discrimination or prohibited transactions
• Validate vesting in distributions to participants
• Confirm prudent investment processes
• Confirm timely deposits of employee deferrals and/or loan payments
• Ensure proper engagement of service providers and reasonable fees for their services
Some overlap of DOL/IRS audits exist, but the major compliance points of interest to the IRS include:
• Alignment of day-to-day operations with a properly executed, up-to-date written legal plan document
• Eligibility, participation, coverage, and minimum vesting standards
• Opening balance, assets, plan expenses, unrealized and realized gains/losses
• Contributions and benefit limits, funding, deductions, disbursements, participant distributions
• Annual nondiscrimination testing, detailed plan census information and payroll report
• Trust activities for plans funded under a trust, custodial account, annuity contract, etc.
• Accurate plan documents and timely filing of returns and reports
What triggers a qualified retirement plan audit?
“Many audits are random,” Bob said. “Sometimes a plan participant fails to send in the right documentation and that can set off an audit, but those situations are usually cleared up in a heartbeat. Over-funded defined benefits plans can trigger an audit, and we have to explain why—maybe the company did very well and just reallocated assets. Shifts in government staffing can create a rash of audits. So far this year we are working on nine plan audits compared with an average of two or three. “As unsettling as an audit notice can be, it’s important to remember that the purpose of an audit is to ensure that everyone is being treated fairly. At the same time, audit failure is serious business because it carries a fine and assets can be frozen. Funds that are owed can be zapped directly out of the plan itself, and now you may have a class action law suit on your hands. The careful eye and expertise that a TPA adds to any qualified retirement plan increases exponentially when an auditor is knocking on the door.”
The ultimate audit advice: Do everything right
One of the best ways to avoid panic and dread and be able to meet the news of a government audit with confidence is to maintain solid internal controls and conduct regular self-audits. “Regulations are complex, which is another reason to work with a highly knowledgeable plan consultant,” said Bob. “Everything about the census is critical information. Payroll has to be identical to what was provided to the TPA including detailed employee information, dates of hire, compensation, hours worked, vesting percentages, and reports. Plan fiduciaries should be able to verify items like timely contribution deposits and monitoring of fees and investment options. Every detail of the plan has to comply with the TPA’s annual administration report that summarizes all plan activity. Everything must reconcile, including beginning balance, investments, summary of accounts, rollovers, associated earnings, assets, contribution sources, and documentation.”
Government audits are never going to be a pleasant experience. However, with the help of a TPA, you can meet that unexpected letter from the IRS or DOL with the assurance that your qualified retirement plan is in total compliance and operating like a reliable, smooth-running vehicle. No problems or surprises lurking beneath this hood!
About The Cerrado Group
The Cerrado Group is a consortium of independently owned, high-performing retirement plan consultant (TPA) firms that help plan sponsors and participants as well as organizations and the entire industry thrive in any retirement plan imaginable. Purposely built around their uncommon diversity, The Cerrado Group guides clients and the industry toward retirements with great confidence. Record-keeping and administration of retirement plans is highly specialized, complex work with far-reaching consequences. The depth of experience our member firms provide includes retirement plan administration, daily valuation, consulting services, and 3(16) fiduciary services.