401(k) Guidance: Unintended Consequences of the New Participant Count Rule

When the Department of Labor (DOL) issued notices in February 2023 announcing changes to the 2023 Form 5500 instructions, a key change was made regarding participant count for determining audit needs.  The deciding number was still 100 participants, but the updated instructions changed the criteria from eligible participants to participants with account balances. 

The change was intended to:

• Reduce the administrative burden and cost of audits for smaller plans;
• and encourage more small businesses to offer retirement plans. 

Upon making the change, the DOL estimated that this change would remove the audit requirement for thousands of plans, affecting 15-20% of all plans that currently needed audits.  For those plans with low participation, this change should work as intended.

Plans Hovering Near the Threshold: Proceed with Caution

But what if you’re a plan for a small business that is trying to grow, and you hover around that 100-participant mark?  Here’s an example: as of December 31, 2022, there were 83 participants with balances in the Plan (130 eligible participants).  Since plan year audits are determined at the beginning of the plan year, the 2022 audit was performed and appropriately filed with the 5500.  For the plan year ended December 31, 2023, no audit was required under the new DOL regulations as less than 100 participants had account balances. Participants with balances increased to 123 as of December 31, 2023, so plan year 2024 will require an audit.

Typically, this would not be a concern, but guess what – there was no audit performed in 2023. Your auditor now has to get comfortable with beginning balances, as well as 2023 plan activity, to ensure that participant balances are properly stated, and the plan was working as designed during that year.  This is based on guidance from the AICPA Employee Benefit Plan Audit Guide.  Not only will testing be performed on 2024 activity and balances, testing will also need to be performed on 2023 activity and balances.  And your proposed audit fee will reflect these additional procedures. 

Skipping an Audit May Lead to More Work Later

Unfortunately, that not’s the only cost.  When the DOL contemplated making the change, reducing the administrative burden was one of the goals.  Your burden will be lessened as compared to two years’ worth of audits, but will it be easy to pull requested information from the prior year?  Hopefully you have a fabulous custodian/recordkeeper and those items are only a few clicks away.  If not, the 2024 audit may not be as easy compared to past audits, and the headache may not be worth the temporary savings on audit fees. 

Consider the Long-Term Trade-Offs

Many audits performed on plans that are smaller in scope identified errors in the operation of the plans.  These identified errors were able to be self-corrected in most cases.  Now, with numerous plans falling below the audit requirement based on the new rules, these errors will likely go undetected, potentially to the detriment of the participants in the plan. 

While the change in participant count certainly benefitted many plans, there will be some that are caught in the middle.  As you monitor the number of participants with balances, make sure you consider the unintended consequences of foregoing the annual 401k audit.  You could consider a consulting engagement or agreed upon procedures engagement to give some limited assurance, which are less expensive than an audit.  In the long run, the benefits you receive in assurance and efficiency from continuing with an audit may ultimately outweigh your “cost” savings.