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Internal Controls are Essential in Retirement Plans

“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 audits 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 revenue 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 the Audit Closing Agreement Program . 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 

These mistakes commonly result from communication problems between the plan sponsor and administrator.

(1) Failure to timely amend the plan or to follow the terms of the plan

It’s common during audits 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 Program 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 to anyone involved in determining deferral amounts, performing nondiscrimination tests or allocating contributions.

(2) 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.

(3) 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. For links to helpful resources, see Retirement Plan Operation and Maintenance and Internal Controls for Plan Sponsors video.