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Certain Small Plans Now Subject to Annual Audit Requirement - April 1, 2002

On October 19, 2000, the DOL issued new regulations (Reg. §2520.104-41(c) and §2520.104-46(b)(1) and (d), 65 F.R. 62958) that now subject certain small plans to an annual audit.  The new rules are “effective for plan years beginning after April 17, 2001.”  This means that the new regulations first apply to employer/plan sponsors with plan years ending April 30, 2002.  However, an exemption to the audit requirement is still available if certain conditions are satisfied.

Background  ERISA requires that all pension, health and welfare and fringe benefit plans that file a Form 5500 must include an audited financial statement and an accountant’s opinion as prepared by an independent qualified public accountant.  Shortly after the passage of ERISA, the DOL issued regulations that provide an exemption to the audit for small plans with fewer than 100 participants as of the beginning of the plan year.  Another rule, the so-called “80/120 participant rule” extends the audit exemption until the first plan year in which a plan covers 120 participants

Conditions for Exemption  To qualify for the plan audit requirement exemption, the qualified retirement plan or the plan’s employer/plan sponsor must continue to satisfy the fewer than 100 participant rule, and the investment or bonding requirements described below (the new audit requirements do not apply to small welfare or 403(b) plans):

Investment Requirement  At least 95% of the plan’s assets must constitute “qualifying plan assets” defined as:

1.   Qualifying employer securities, such as employer stock or other marketable obligations issued by an employer of the employees covered by the plan (or by an affiliate of such employer);

2.   Participant loans that meet the prohibited transaction exemption requirements of ERISA;

3.   Assets held by a regulated financial institution, such as an insurance company, bank or similar financial institution;

4.   Shares issued or held by an investment company registered under the Investment Company Act of 1940 (e.g., registered mutual funds);

5.   Investments and annuity contracts issued by an insurance company qualified to do business under the laws of any state; and

6.   In the case of an individual account plan (e.g., a profit sharing plan), any assets in an account of a plan participant or beneficiary who has the opportunity to exercise investment control and for which the participant or beneficiary is furnished, at least annually, a statement from a regulated financial institution describing the assets held (or issued) by such institution and the amounts of such assets.


Bonding Requirement  The new bond requirement is the greater of 10% of the total assets or 100% of the total amount of assets considered “non-qualifying plan assets” defined to include plan assets that do not fall into any of the categories above, such as real estate interests held by parties that are not regulated financial institutions, stock certificates held by the sponsor or trustee rather than in the street name by a brokerage firm, or limited partnership interests.  The following show how the new rules apply:

Example 1  A plan has total assets of $500,000 that include $450,000 invested in assets held by various banks, insurance companies and mutual funds, $30,000 in participant loans and $10,000 in a real estate limited partnership as of the end of its plan year ending December 31, 2001.  This plan is not subject to the new audit requirement since the “non-qualifying” plan assets constitute only 2% of the plan assets (since $10,000 divided by $500,000 or 2% is less than 5%).

Example 2  Similar fact pattern to example 1 however, the total assets of $500,000 include $400,000 invested in assets held by various banks, insurance companies and mutual funds, $30,000 in participant loans and $70,000 in a real estate limited partnership.  This plan is subject to the new audit requirement since the “non-qualifying” plan assets constitute 14% of the plan assets (since $70,000 divided by $500,000 or 14% is greater than 5%).  To obtain the audit exemption, the employer must increase the normal 10% fidelity bond requirement ($50,000) to $70,000.

Example 3  Same fact pattern as example 2 however, a bank serves as trustee for the total assets of $500,000 (that continue to include the $70,000 in non-qualifying assets).  Since a regulated financial institution now holds 100% of the assets, they are “qualifying plan assets” and the increased bonding is not required for the audit exemption.

Disclosure Requirements  The plan must also provide certain additional information in the SAR (the DOL required summary of the annual report (Form 5500) to plan participants) as follows:

1.   Names of financial institutions holding (or issuing) qualifying plan assets and the amount of such assets reported by the institution as of the end of the plan year;

2.   Name of the surety company issuing the bond (if the plan has more than 5% non-qualifying plan assets);

3.   The right of participants and beneficiaries to request, examine or receive year end statements received from the regulated investment companies holding qualifying plan assets and evidence of the required bond; and

4.   A notice that participants and beneficiaries should contact the Pension and Welfare Benefits Administration (PWBA is part of the DOL) if they are unable to examine or obtain certain documents from the plan sponsor.


These additional disclosure requirements do not apply to investments in qualifying employer securities, participant loans and participant-directed investments as described in 1, 2 or 6 of the “qualifying plan assets” definition above.

Lastly, keep in mind that these new rules are subject to modification by pending legislation resulting from the ENRON scandal.  Please contact our office if we can be of further assistance with this matter.

Full text of DOL Regulation §2520

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© 2002 Milberg Consulting LLC  All Rights Reserved

We intend the information in this publication as a general resource, not as legal or plan compliance advice or counsel. If you consider any actions discussed in this update, we suggest that you consult a tax or ERISA professional. Milberg Consulting LLC and Barry R. Milberg do not warrant and are not responsible for any errors and omissions from this update.