80-120 Participation Rule for 401(k) Audits

When Does an Employee Benefit Plan Become a “Large Plan” and Require an Audit by a Certified Public Accountant?

The general rule states that plans with 100 or more participants are categorized as “large plans.”

The 80-120 Participant Rule: If the general rule were applied without exception, plans that frequently fluctuate between slightly more or less than 100 participants would have to switch between being categorized as a “small” plan and a “large” plan, which could be inconvenient and disruptive. Thus, an exception to the general rule is provided by DOL Reg. 2520.103-1(c) and (d). The regulation provides relief from having to switch to the reporting requirements that the general rule would otherwise require. It provides that plans with between 80 and 120 participants (inclusive) at the beginning of the current plan year may elect to complete the current year return using the same category (that is, “large” plan or “small” plan) that was used in the previous year.

• Thus, for example, if a plan that had 115 participants at the beginning of the 20X1 plan year was considered a “small” plan for the previous year, the plan may complete the Form 5500 using the “small” plan category again in 20X1 (rather than having to use the “large” plan category) and each subsequent year until the number of participants exceeds 120.

• Similarly, if a plan that had 95 participants at the beginning of the 20X1 plan year was considered a “large” plan for the previous year, it may elect to file Form 5500 again in 20X1 as a “large” plan, rather than follow the general rule and switch to the “small” plan category. Such a plan might elect not to switch but to file the Form 5500 again as a “large” plan if the decline to 95 participants was considered to be temporary and it was considered likely that next year the plan would exceed 120 participants and thus would again have to file Form 5500 as a “large” plan. Note that the exception is designed to avoid having to switch filing categories; it does not necessarily permit switching categories just because a plan falls within the 80-120 participant range.

• Thus, if a plan with 115 participants at the beginning of the 20X1 plan year had filed Form 5500 as a “large” plan for the previous year, it could not switch to filing Form 5500 this year as a “small” plan just because it had between 80-120 participants, but would have to file Form 5500 again as a “large” plan.

• Likewise, if a plan that had 95 participants at the beginning of the 20X1 plan year had filed Form 5500 as a “small” plan for the previous year, it need not switch to filing Form 5500 as a “large” plan this year just because it had between 80-120 participants. Exhibit 1 summarizes the filing possibilities under the “80-120 participant” rule.

Exhibit 1 Filing Provisions for Plans with 80-120 Participants

Number of Participants at Beginning of Current Year Requirements Followed for the Previous Year Form 5500 Requirements to Be Followed for the Current Year Form 5500
Fewer than 80 “Small” plan “Small” plan
Fewer than 80 “Large” plan “Small” plan
80-99 (inclusive) “Small” plan “Small” plan
80-99 (inclusive) “Large” plan May elect to file Form 5500 again as a “large” plan or switch to a “small” plan
100-120 (inclusive) “Small” plan May elect to file Form 5500 again as a “large” plan or switch to a “small” plan
100-120 (inclusive) “Large” plan “Large” plan
More than 120 “Large” plan “Large” plan
More than 120 “Small” plan “Large” plan

Determining the Number of Participants

As discussed in the preceding paragraphs, the Form 5500 reporting requirements vary based on the number of plan participants. Thus, determining the number of participants is crucial to determining which schedules should be filed with the Form 5500. Line 7 of Form 5500 details the number of participants at the end of the plan year, and the instructions to Form 5500 lines 6 and 7 give guidance on counting the number of participants. Participants include the following:

• Active Participants - Active participants   include current employees who are earning or retaining credited service under the plan including nonvested participants. This category does not include nonvested former employees who have incurred a break in service or former employees who have received a deemed distribution or a “cash-out” distribution of their entire nonforfeitable accrued benefit. The authors believe that employees who have rolled over amounts into the plan but are not yet eligible participants should not be counted.

• Retirees or Separated Participants Who Are Receiving Benefits - Former employees receiving group health continuation coverage and who are covered by the employee welfare benefit plan are included as participants. Those for whom an insurance company has made an irrevocable commitment to pay all benefits are not included.

• Retirees or Separated Participants Entitled to Begin Receiving Benefits in the FutureThe authors believe that terminated employees who still have balances that will or must be withdrawn (rolled over), but have not been, must be counted. Former employees for whom an insurance company has made an irrevocable commitment to pay all benefits (that is, those covered by an allocated insurance contract) are not included as participants.

• Beneficiaries of Deceased ParticipantsBeneficiaries currently receiving benefits or entitled to begin receiving benefits in the future are included as participants. Those for whom an insurance company has made an irrevocable commitment to pay all benefits (that is, those covered by an allocated insurance contract) are not included.

• Dependents are not participants or beneficiaries in counting participants for purposes of a welfare benefit plan. For example, an employee’s family members who are covered by the company health insurance plan would not be counted as a participant or beneficiary.

• Alternate payees entitled to benefits under a qualified domestic relations order and children that are alternate recipients entitled to health benefits under a qualified medical child support order are not considered participants.

If you are unsure of your benefit plan’s audit requirement or need more information regarding the 80-120 rule, please contact Paul McGovern at pmcgovern@downeycocpa.com or at  800-849-6022.  For a free 401(k) audit quote, please click here.