Background Information
A 401(k) plan (sometimes called a cash-or-deferred arrangement or CDA) may be incorporated
into a profit-sharing, stock bonus, thrift, or savings plan. A 401(k) plan gives participants the
option of receiving a cash payment immediately (salary) from the employer (taxable) or having
the cash contributed to the plan as contributions on the participant's behalf (tax deferred).
Government and not-for-profit entities have 403(b) plans that are similar in nature to the 401(k)
plans. While this course does not specifically address governmental plans, certain auditing
procedures discussed herein might be helpful to the auditor of governmental plans. Beginning
January 1, 2009, certain 403(b) plans (primarily those with 100 or more participants) have an
audit requirement.
A 401(k) plan may be sponsored by a single employer, multiple employers, or under a
multiemployer arrangement. The majority of 401(k) plans are single employer plans; however,
you should be aware of the existence of multiemployer plans. The most basic distinction
between single and multiemployer plans is how they are administered. Single employer plans
are generally established and operated by the management of one employer or a controlled group
of corporations, called the plan sponsor. In contrast, multiemployer plans are typically
established through collective bargaining agreements negotiated between a group of employers
(e.g., construction) and the union representing the employees. These plans are managed by a
joint employer/union board of trustees.
The various types of defined contribution plans that 401(k) plans are typically part of are briefly
described below. Such plans can permit employee contributions. The distinguishing
characteristic of the plans is often how the sponsor contribution is derived or treated.
• A profit-sharing plan is a defined contribution plan that is not a pension plan or a stock
bonus plan. It is a plan in which the sponsor contributes money to participants' accounts
either on a discretionary basis (i.e., not mandatory) or as a percentage of profits,
compensation, or other factors. A profit-sharing plan must be designated as such in the
plan document.
• A stock bonus plan is a defined contribution plan in which employer contributions to the
plan are normally made in the stock of the employer. If stated in the plan document, the
participant may request to be paid in cash instead of employer stock.
• A thrift or savings plan is a profit-sharing or stock bonus plan whereby participants make
contributions to the plan from after-tax dollars. Employee contributions are often
matched by the sponsor, either in whole or in part.
When participants elect to contribute to a 401(k) plan they agree to have a portion of their wages,
before income taxes, contributed to specific investments. These contributions are taken out of
their wages and invested in the investment option(s) offered by the plan and selected by the
participant. Plans also may provide for after-tax contributions, or may offer a Roth 401(k)
feature, in which contributions are made on an after-tax basis.
The pre-tax deductions that the participant makes are called deferrals and are generally
calculated as a percentage of total compensation. In other words, for each payroll cycle, the
stated percentage amount is deducted from the participant's gross income before taxes are
withheld and this money is then invested in the 401(k) plan. The employee can change the
deferral rates periodically as permitted by the plan document. Many plans now have automatic
enrollment or the ability for the participant to change their contribution percentage via an online
system.
Defined contribution plans require that a separate account be maintained for each participant.
This provides the participant with information as to total dollars in his/her account and the
allocation of those dollars among the various investment options. Each individual participant
account is maintained within the plan. In a 401(k) plan, generally, participants direct the
selection of investments in their account and bear the investment risk of their individual account.
The value of a participant's account fluctuates according to (a) amounts contributed to the
account by the sponsor and/or participant, (b) investment experience on such amounts, (c)
participant-initiated withdrawals, (d) expenses, and (e) any forfeitures allocated to the account.
Many plans permit a participant to withdraw a portion of his/her account in the form of a loan
from the plan. Loans by participants are treated as assets of the plan. Withdrawals from the plan
can be made according to the provisions of the plan, when an employee terminates employment,
retires, or is eligible for a hardship withdrawal. In addition, certain plans allow for participants
to borrow against their account in the form of a participant loan. (See Chapter 4 for further
information.)
Under a defined contribution plan, the sponsor contribution rate is generally determined
periodically at the discretion of the sponsor or by contractual agreement, or both. When a
participant retires or withdraws from the plan, the amount allocated to the participant's account
(i.e., the vested amount) represents the participant's accumulated benefits. Participants are always
fully vested in the amount of their employee contributions. The vested amounts of a participant's
account balance may be paid to the participant or used to purchase a retirement annuity.
(Vesting will be discussed in more detail in Chapter 5.)
Operation and Administration
A 401(k) plan is contributory, with contributions from both employers and participants or from
participants only. Contributions from employers may be discretionary or may be required.
A defined contribution plan is established by the plan document and relevant plan provisions are
detailed in the plan document. These provisions are established and maintained by the plan
sponsor. They define such matters as age and service requirements, which must be satisfied to
allow an employee to participate in the plan, vesting, and loans. They also identify the plan's
fiduciary(ies), fiduciary responsibilities (those relating to maintaining control and management
of the plan) and the delegation of fiduciary responsibilities in connection with the administration
of the plan. A plan subject to the Employee Retirement Income Security Act of 1974 (ERISA)
must be in writing. Sponsoring organizations, i.e., banks, insurance companies, and/or stock
brokers, prepare and update standard plans called master or prototype plans that are available to a
plan sponsor to enable them to establish a qualified plan by customizing a standard plan to meet
the plan sponsor's needs. These standardized plans generally have IRS approval.
The named fiduciary is responsible for the general operation and administration of the plan in
addition to identifying a plan administrator. The plan administrator of a single employer plan is
usually an officer or other employee of the plan sponsor, while the plan administrator for a
multiemployer plan generally is a board of trustees. The plan administrator reports directly to
those charged with governance of the plan, which may be an oversight committee or the plan
sponsor’s board of directors or other management group. The fiduciary has responsibility to
ensure that the plan is operating in accordance with the terms of the plan document, trust
instrument, if any, and all applicable government rules and regulations. Generally, the fiduciary
makes decisions regarding the interpretation of rights of the participants under the plan, how
investments are to be managed, and the performance or the delegation of responsibilities for
operating and administering the plan.
The ultimate responsibility for the oversight of the plan rests with the fiduciary. However, the
plan's day-to-day administration (e.g., collecting contributions, paying benefits, managing cash
and investments, loan administration, maintaining records, and the preparation of reports) is
often assigned to various entities such as (a) the plan sponsor, (b) a trustee, such as a trust
department of a bank or insurance company, (c) an investment advisor, (d) a third party
administrator or recordkeeper, or (e) a person or persons designated as the plan administrator.
A plan usually has a trust instrument or agreement that details the authority and responsibilities
of the trustee(s) and any investment advisors or managers. This document should include or be
consistent with the plan's investment policy and therefore may restrict the investment options
permitted by the plan. In addition, the trust agreement should describe the fees to be paid to the
trustees, investment advisors, and managers for services provided to the plan. It also will
describe who is responsible for payment of these services, i.e., the participants or the plan
sponsor.
The DOL has launched an education campaign to educate plan sponsors regarding their fiduciary
responsibilities under the Employee Income Security Act of 1974. As part of this campaign they
have published several publications, including one entitled
Meeting Your Fiduciary
Responsibilities.
Accounting Records
Accounting records for a defined contribution plan should be maintained in a reliable manner so
as to permit effective management and operation of the plan. Accounting records must be in a
format that will ensure reliable financial reporting of the plan. The complexity of the plan will
determine the nature of the accounting records and will vary with such factors as the frequency
of sponsor contributions, the number of investment options available for participants to select,
rules regarding the administration of loans, the variety of options available to terminated
participants, and the delegation of administrative duties.
The various accounting and plan records of a 401(k) plan are often maintained at several
locations. Depending on the nature of the plan, how fiduciary responsibilities are allocated, and
who is responsible for various administrative duties, plan records may be maintained by various
trustees, insurance companies, record keepers, the plan administrator, and the plan sponsor,
including the payroll and human resources departments.
The records of the plans normally should include the following:
• Investment asset records – ERISA requires detailed reporting of investment assets in
addition to the supplemental schedules. The supplemental schedules include schedules of
(a) assets (held at end of year); (b) assets (acquired and disposed of within year); (c) loans
or fixed income obligations in default (d) leases in default or classified as uncollectible;
(e) reportable (5%) transactions; and (f) non-exempt transactions. See Chapter 9,
"Supplemental Schedules," for additional information on the contents of the supplemental
schedules. These records are generally maintained by the trustee/custodian and/or plan
sponsor.
• Participants' records – Records should be maintained to determine each employee's
eligibility to participate in the plan. Many plans have age and service requirements that
the employee must satisfy before he/she is eligible to participate in the plan. Eligibility
also can be affected by breaks in service (leaving the employment of the plan sponsor and
then returning or taking long-term disability, for example). These records are generally
maintained by the human resources and payroll departments at the plan sponsor or the
administrative office or a third party administrator for a multiemployer plan.
• Contribution records – Separate contribution records should be maintained for employee
and sponsor contributions. The plan sponsor generally retains payroll records detailing
employee contributions. Sponsor contributions should be accounted for separately to
ensure that the contributions are being made in accordance with the plan document. As
with participant contributions, the plan sponsor maintains records of sponsor
contributions.
You should be aware that many plans now accept contributions into a Roth IRA account.
Contributions into a Roth IRA are made post-tax (after all federal, state, etc., taxes are
withheld as opposed to a 401(k) contribution that is made pre-tax). However, subsequent...
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