Audits of 401(k) Plans

Over 400,000 benefit plans have 401(k) features, making it vital that CPAs know the audit requirements and the latest developments affecting them. Focus on every aspect of how to audit a 401(k) plan and prepare financial statements that satisfy ERISA and SEC requirements.

• Understand the requirements for 401(k) audits as distinguished from audits of other types of employee benefit plans
• Recognize new developments affecting 401(k) audits
• Plan and conduct 401(k) audits more efficiently and effectively

Prerequisite:  Knowledge of ERISA and IRS requirements for benefit plans.

Chapter 1

Upon completion of this chapter you should have

• An understanding of the basic features of 401(k) plans.
• An understanding of the general features of 401(k) plan operation and administration.
• An understanding of the general reporting requirements for 401(k) plans.

This course has been prepared to assist the independent qualified public accountant in accounting, auditing, and reporting on financial statements of 401(k) defined contribution retirement plans. This course will help the auditor identify the uniqueness of these types of audits.

Generally accepted auditing standards and generally accepted accounting principles apply in general to employee benefit plans. This course assumes that the user is generally knowledgeable in the field of accounting and auditing. Rather than discussing the broad application of those standards and principles, the course focuses primarily on the special issues involved in accounting, auditing, and reporting on financial statements of 401(k) employee benefit plans. The course does not discuss the application of all generally accepted accounting principles and auditing standards as they pertain to the auditing of general financial statements.

This course has been updated to reflect the following accounting and auditing standards.

• In December 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) AAG INV-1 and SOP 94-4-1, Reporting of Fully Benefit-Responsive Investment Contracts Held by Certain Investment Companies Subject to the AICPA Investment Company Guide and Defined-Contribution Health and Welfare and Pension Plans, which provides guidance on the presentation and disclosure of fully benefitresponsive investment contracts. FSP AAG INV-1 and SOP 94-4-1 are effective for financial statements ending after December 15, 2006, with retroactive application to all prior periods presented. See Chapter 4 of this course for guidance on how to present and disclose these investment contracts as a result of this FSP.
• In March 2006, the AICPA's Auditing Standards Board issued eight SASs (SAS Nos. 104-111) related to risk assessment. These SASs are effective for audits of financial statements for periods beginning on or after December 15, 2006 (with early adoption permitted).
• In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands its discussion on financial statement disclosures regarding fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within these fiscal years, with earlier adoption encouraged, provided that the reporting entity has not issued any financial statements for that fiscal year, including interim financial statements. See Chapter 4 of this course for guidance on how to measure fair value for various investments and the necessary disclosures.

This course focuses on single-employer sponsored 401(k) plans. However, the course does include certain comments on multiemployer-sponsored plans. Multiemployer-sponsored 401(k) plans would be treated as single-employer plans for purposes of reporting to the regulatory agencies described in the following text.

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,"Participant Loans" section, 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, in the section"Contributions from Employers.")

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.

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