Do I Need a 401(k) Audit?

The Basic Rule -- 120 Participants with Balances

Under ERISA and Department of Labor regulations, any retirement plan that files as a "large plan" on Form 5500 must include an independent auditor's report. The threshold that triggers this requirement is straightforward: 120 or more participants with account balances on the first day of the plan year.

This counts participants who have account balances in the plan -- active employees with balances, former employees who never rolled over, retirees receiving distributions, and beneficiaries with remaining balances. The count is often larger than most plan sponsors expect.

Once your plan crosses that 120-participant threshold on the first day of the plan year, you are required to file a Form 5500 as a "large plan" and attach an Independent Qualified Public Accountant (IQPA) report -- in other words, you need an audit.

The 80-120 Rule

This is where the nuance comes in. The DOL created what is commonly known as the "80-120 rule" to prevent plans from flipping back and forth between small and large plan filing status every year. Here is how it works:

• Once your plan crosses 120 participants with account balances, you must file as a large plan and get an audit. No exceptions.
• Once you are filing as a large plan, you continue filing as large -- and continue needing an audit -- until your participant count with balances drops below 80.
• The 80-120 corridor prevents plans from flipping between small and large plan status. Once you cross 120, you remain a large plan filer until you drop below 80 participants with balances.

This rule exists for practical reasons. Without it, a plan hovering around 120 participants could be required to get an audit one year, skip it the next, then get one again -- creating inconsistency and administrative headaches for everyone involved.

First-Year Exemption

New plans in their first year of existence are not required to have an audit, regardless of how many participants they have. If you launch a 401(k) plan today with 200 participants with balances, you will not need an audit for that first plan year.

This exemption applies strictly to the first plan year only. Starting in year two, the standard participant-count rules apply and you will need to determine your filing status based on the count at the beginning of that second year.

What Counts as a "Participant with a Balance"?

For audit threshold purposes, you count participants who have account balances in the plan. This includes:

• Active employees currently contributing to the plan
• Former employees who still have account balances in the plan
• Retired employees receiving distributions from the plan
• Deceased participants whose beneficiaries still have balances in the plan

Eligible employees who never enrolled and have no account balance are not counted toward the 120-participant threshold. However, plan sponsors are often surprised by how many former employees and retirees still have balances. That employee who left three years ago but never rolled over their balance? They count.

What Happens If You Don't Get an Audit?

Filing a Form 5500 without a required audit report is not a gray area -- it is a compliance failure with real financial consequences. Here is what you are looking at:

• DOL penalties of up to $250 per day for late or incomplete filings, capped at $150,000 per plan year
• IRS penalties for late Form 5500 filing, which can reach $250 per day up to $150,000
• Possible plan disqualification in extreme cases of non-compliance
• A DOL letter demanding immediate compliance and potentially triggering a broader examination of the plan

These penalties can stack up quickly. A plan that misses its audit for even one year can face tens of thousands of dollars in fines. And the longer you wait to address the issue, the more expensive it becomes. Acting promptly is always less expensive than waiting.

What If the DOL Already Contacted You?

If you have received a letter from the Department of Labor about a missing audit, the first thing to know is: do not panic, but do not ignore it either. These letters are serious, but there are well-established paths to resolution.

The most important step is to engage a qualified auditor immediately. An experienced retirement plan auditor can help you understand the scope of the issue and begin the compliance process. In many cases, you may be able to use the DOL's Delinquent Filer Voluntary Compliance Program (DFVCP) to significantly reduce penalties -- sometimes to as little as $750 per plan year, compared to the statutory maximums described above.

The DFVCP is available for plans that have not yet received a DOL penalty notice. If you have received a notice, there may still be options for negotiation, but the window narrows. The sooner you act, the more leverage you have.

PEPs and MEPs

Pooled Employer Plans (PEPs) and Multiple Employer Plans (MEPs) follow the same 120-participant rule, but with an important distinction: the participant count is for the entire plan, not for individual adopting employers.

If a PEP has 120 or more total participants with account balances across all of its adopting employers, the plan as a whole needs an audit -- even if no single employer has anywhere close to 120 participants on their own. This is one of the reasons PEPs almost always require an audit from their very first filing year (after the first-year exemption): they tend to aggregate enough participants from their employer base to cross the threshold quickly.

For MEPs, the same logic applies. The plan is treated as a single entity for filing and audit purposes, and the aggregate participant count determines the filing status.

Decision Flowchart

If you land on step five and are unsure about your prior year filing status, check your most recent Form 5500. The filing type (large or small) will be indicated on the form. If you have never filed, you are starting fresh and should evaluate based on your current participant count.