Recent Posts:Using Force Out Distributions to Avoid a 401(k) AuditIf you seek avenues to avoid a costly 401(k) audit, your focus should be headcount. Why headcount? Because it is what the government uses as a measuring stick to determine which plans must be audited. It also pays to read industry publications, like the free PlanSponsor magazine, to stay current with the ever-changing regulatory landscape. Between recent Acts of Congress and rule changes implemented by the IRS, there are currently two unrelated changes to be aware of. Both can potentially reduce the number of plans subject to audit significantly.
Form 5500 changes The first change relates to revisions to the 2023 IRS Form 5500 instructions—specifically, revisions to the methodology for determining who is labeled as a participant. In short, a participant is now defined as someone with a balance in the plan, versus the historical classification being someone eligible to participate (whether they participated or not). While this change has been known for about a year, audits are backward-looking, so the changes will first be felt in 2024. The Department of Labor estimates that the change in methodology will translate to approximately 20,000 plans that will no longer require an audit (or about 15% of plans that were audited in 2022).
Mandatory cash-outs The second change is brought on by SECURE 2.0, a sequel to the 2019 SECURE Act. SECURE 2.0 reforms the retirement plan landscape, and we will review some of the more confusing 2.0 changes in future posts. Today, our takeaway focuses on the unambiguous provision concerning mandatory cash-out limits (as the limits are about to increase). Beginning January 1, 2024, former employees with vested balances under $7,000 can be automatically “cashed out” (i.e., forced to take final distributions). This threshold has increased from the current limit of $5,000. It is important to stress that if the Plan allows them, these cash-outs may be processed without obtaining consent from the participant. Procedurally, there are no changes to the existing force-out process. Namely, amounts over $1,000 (or those between $1,000 and $7,000) are to be rolled in the participant’s name to a qualified institution, while distributions under $1,000 can be directly payable to the participant.
Headcount and the 401(k) audit requirement: Why are these changes impacting the number of audits? It is because a 401(k) audit is mandated based on headcount. Audits are required for plans with over 100 participants in the year of inception or when a plan began small and grew to 121 participants over time.
Why cash-out distributions matter: Processing force-out distributions provides many benefits, including reduced administrative costs, simplified plan management, and potential relief from compliance and reporting requirements, including audits for plans triggered by numerous small accounts. Despite most plans allowing for mandatory force-out distributions, only about half of the plans we audit regularly process cash-out distributions. This is essentially an unforced error. Even if you can’t shed enough participants to skirt the 401(k) audit requirement, it is still likely healthy to regularly flush these employees from your plan as many 401(k) costs are based on asset levels or headcount.
Conclusion: Form 5500 methodology changes have almost certainly lowered your headcount, but maybe they haven’t lowered it enough to avoid an audit. This is where you may be able to lower your participant count further using the mandatory cash-out distributions. If you have questions about force-out distributions, please don't hesitate to contact us for further discussion.
Scott M Dufek, CPA | 12/27/2023
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