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Internal Controls are Essential in Retirement Plans

Monika Templeman, Director of EP Examinations, responds to questions and offers insights on retirement plan topics uncovered during audits. You may provide feedback or suggest future topics by emailing her at: RetirementPlanComments@irs.gov.

“An ounce of prevention is worth a pound of cure” definitely applies to keeping retirement plans tax-qualified. Effective internal controls and annual reviews of your plan are essential “ingredients” to prevent costly mistakes that can jeopardize the plan’s tax-favored status. Unfortunately, retirement plan examinations and voluntary correction submissions often reveal that plans don’t have needed internal controls in place or they aren’t administered properly.

Benefits to having strong internal controls

Having effective practices and procedures to prevent compliance problems is a basic requirement to be eligible to use the Self-Correction Program. You can self-correct insignificant operational errors at any time and preserve the tax-favored status of the plan without having to pay any fees.

When auditing a retirement plan, the agent begins by evaluating the plan’s internal controls to determine whether to perform a focused or expanded audit. In addition, if the agent finds plan errors, the strength of internal controls is a factor in the negotiation of the sanction amount under Audit CAP. The agent will make every effort to ensure that the plan has internal controls in place when the audit concludes.

Please note that hiring a service provider doesn’t relieve you of the responsibility of keeping your plan in compliance. Problems typically occur when there’s a communication gap between you and the plan administrator about what the plan document provides and what documentation is needed to ensure compliance.

Common mistakes that we see during plan audits resulting from communication problems between the plan sponsor and administrator

Failure to timely amend the plan or to follow the terms of the plan

It’s common during examinations that an employer can’t locate documentation to prove the plan was timely amended for current law. This results in an Audit Closing Agreement under Audit Cap. If the error had been discovered through an annual review of the plan document before the plan was audited, the plan sponsor could have filed a much less expensive voluntary correction submission to bring the plan current with all law changes (self-correction isn’t available for document failures).

When you change your plan document, you should also make corresponding changes to the summary plan description and communicate the changes to plan participants. It’s also important to share changes made to the plan with all persons who provide service to the plan. For example, if the plan’s definition of compensation is changed, you should communicate this change with anyone involved in determining deferral amounts, performing nondiscrimination tests or allocating contributions.

Failure to review in-service, termination, and loan distribution forms to make sure they follow the plan terms

Many plan vendors use the same distribution forms for all of the plans they administer despite the fact that individual plans may have different distribution options and requirements. Using a generic form can lead to incorrect distributions and incorrect tax reporting.

Failure to count all eligible employees in testing

Plan sponsors often fail to share information with the plan administrator on all employees:

  • eligible to make an elective deferral, including those terminated during the year, or
  • of a related company with common ownership interests.

These employees may be eligible to participate in the plan and, therefore, may need to be included in the various tests.

Free tools

The tools on our website can help you strengthen your plan’s internal controls. We have checklists that ask questions relating to common errors found in certain types of plans. If you answer “no” to any of the questions, you should investigate further to see if you have an error in your plan. If you sponsor a 401(k) plan, use our 401(k) questionnaire, which contains more questions that may help determine if there are errors in your plan. We also have Fix-It Guides for a number of plan types with tips on how to find, fix and avoid common plan errors. The Trends and Tips pages list recurring errors by plan type and issue, and include errors we found in large case (EPTA) exams.

The tips in this article and the related links are the ingredients we have available for your retirement plan “ounce of prevention” recipe. So, if you haven’t done so already, please check out our user-friendly tools on the Information for Retirement Plans Web pages.

Page Last Reviewed or Updated: 24-Jun-2013