Form 5500 Red Flags to Avoid

Your work in filing an accurate Form 5500 is important to keep your plan healthy and free from Department of Labor scrutiny. From time to time, the DOL performs random audits on retirement plans to ensure compliance with ERISA’s rules and regulations. While the DOL does not detail the factors that trigger an investigation, there are many “red flags” you can avoid in order to lower your chances of an audit. Keep these red flags in mind as you prepare to file the Form 5500 to keep your report consistent with generally accepted best practices.

Missed 5500 Filing Deadlines

You or your 401(k) service provider can request an extension by filing IRS form 5558 if you are unable to file the Form 5500 on time. This will extend your deadline to October 15 at the latest. It is critical to both complete Form 5558 and mark the box on Form 5500 indicating you are filing with an extension, should you choose to do so.

You are still required to file even if you miss the final October 15 extended deadline. Your chances of being noticed by the DOL may increase significantly, however, if you do miss that final deadline. Filing past the final deadline requires employers to satisfy the DOL’s Delinquent Filer Voluntary Compliance (DFVC) program, which involves marking that you are delinquent and sending additional paperwork to the IRS. As long as this program is completed, the IRS will generally waive penalty fees associated with delinquent Form 5500 filings.¹ While it’s better to take this route than not file at all, the best way to stay in compliance is to file on time.

Incorrect Details and Typos

The Form 5500 is similar to many other government forms. It deals with many detailed questions, and asks employers who complete the form to pay close attention to a long list of codes made up of letters and numbers that tell the DOL specific details of the plan. For example, Part 4 question 9A describes the type of plan. Is yours a traditional 401(k), or profit sharing, or a participant-directed plan? Each plan type has its own unique code that must be entered correctly, or it could cause the entire filing to come into question. 

Typographical errors are just as likely to cause issues. Sometimes, all it takes is entering “Yes” on the wrong line when you meant to enter “No.” That answer could give the DOL reason to believe your plan is out of compliance. 401(k) service providers typically use software to help make this element of filing easier, but manual entry creates a significant opportunity to enter incorrect information. Be sure to review your Form 5500 closely before filing to catch errors before they make it into the DOL system.

Potential Evidence of Noncompliance

All 401(k) plans must follow ERISA rules in order to stay in “compliance” with regulations. No two 401(k) plans are exactly alike, but there are some qualities that can cause the DOL to take a closer look for noncompliance—or a breach of any of ERISA’s rules. Note that some of these red flags must be accounted for when filing the Form 5500, as they represent greater administrative problems with a plan. Any of the following issues could stand out as a red flag, even though they may not be an issue for your plan in particular:

• Multiple Plans with the Same EIN – Potential Control Group Issues
  The DOL allows certain groups of companies connected by common ownership to create unique retirement plans for each business in the group. This is called a “controlled group,” and it is common in some industries. For example, an auto dealer might have multiple locations with a separate 401(k) plan for each one. If you have plans in a controlled group, you must enter a code in the Form 5500 to indicate so. Otherwise, the DOL could interpret multiple plans administered by one entity with a single Employer Identification Number (EIN) as an attempt to limit the number of employees participating in each plan in order to avoid audit requirements.
• Corrective Distributions – Giving Money Back to Employees
  When a plan fails annual nondiscrimination testing, it may be required to issue “corrective distributions” to certain employees. When that happens, highly-paid employees who contributed too much to the plan must receive a portion of their savings back—and pay income taxes on that money. The IRS may see a red flag, and pay closer attention to the plan, when corrective distributions aren’t made by the deadline.
• Deemed Loans – 401(k) Loan Defaults
  Some 401(k) plans allow employees to take loans out against their savings. In the event that an employee goes into default with repayments, a loan is considered “deemed,” which means it must be considered a distribution subject to early withdrawal taxes and penalties. A deemed loan could happen not because the employee didn’t intend to pay a loan back, but because there was an issue with the loan repayments being taken out of the employee’s paycheck. For that reason, the DOL may view the reporting of any deemed loans as a potential administrative problem.
• Late Contributions – Money Not Entering 401(k) Accounts on Time
  A common 401(k) administration issue is the late funding of payroll contributions to 401(k) providers on time. When this happens, money that was deferred by employees takes too long to enter their 401(k) account, which means missed opportunities for earning investment growth. Learn more about how to avoid this administrative red flag in our article, How to Avoid Common 401(k) Administration Issues.
• Fidelity Bond Noncompliance – Insufficient Fraud Insurance
  A large section of the Form 5500 deals specifically with compliance questions, including question 10 about 401(k) Fidelity Bonds. ERISA requires fiduciaries with a direct hand in managing any 401(k) plan to be bonded in order to protect against losses due to fraudulent activity or theft. Especially with smaller plans, sometimes the Form 5500 will accidentally carry over a bond amount from a previous year, which may not be sufficient to cover the current requirements.
• Outside Investments – Savings Invested Outside the 401(k) Fund Lineup
  Sometimes, employees in a retirement account may invest their savings outside the standard funds included in the plan’s investment lineup. This could include anything from stock in the employer’s company, to physical assets like art or real estate. These investments could be acceptable, but also represent a higher-than-usual risk for benefit to the employer, or for unreasonable investment fees. 

Keep in mind that the presence of any of these scenarios in your Form 5500 filing may be unavoidable due to the administration of your plan during the calendar year in question. In the event that you find yourself reporting any of the above, it may be in your best interest to correct problems immediately in order to avoid future issues with future year filings.

The IRS offers three programs for correcting plan failures. The Self-Correction Program (SCP) allows employers to correct certain plan failings without the need to pay a fee or contact the IRS. In early 2019, the SCP was expanded to cover several additional plan failures involving 401(k) loans. Additionally, for issues that cannot be self-corrected, there is the Voluntary Correction Program (VCP) which requires contact with the IRS, and the Audit CAP which is used to correct plan failures uncovered during an audit.

Inconsistencies Between Filings

Through the years, each annual Form 5500 filing picks up where the last one left off, exactly one day later. Because of this, successive filings should be consistent when it comes to basic information. Inconsistencies could happen as a mistake, or could signal to the DOL that something inappropriate is happening within a retirement plan.

For example, a common inconsistency is a change to the company’s employer identification number. There are many valid reasons why an EIN may change for a plan from year to year. This could include a change in ownership, or a transition between company types like a change from a sole proprietorship to a partnership, or a limited liability company to a corporation. If this happens, line 4 of the first section of the Form 5500 must be filled out in order to indicate the reason for a change. If this is accidentally left incomplete, it can raise questions.

Additionally, there are simple numbers that should remain unchanged from the end of one year’s filing to the beginning of the next. The beginning-of-year asset value should be the exact same number as the end-of-year asset value indicated in your previous filing. With New Year’s Day being a federal bank holiday, there has been no opportunity for any changes to occur between December 31 and January 1, so a change in this value may be seen as an intentional attempt to manipulate the numbers. Sometimes New Year’s Day is observed on January 2 or 3 when it falls on a weekend, but this timeline is still too short to allow for significant changes.

The same logic applies to the number of employees participating in the plan. When a plan reaches 120 participants, it inherits some additional regulatory burden; a costly annual plan audit will be required, and the plan will have to switch from the short form 5500-SF to the long form 5500. These requirements aren’t waived until a plan goes back under 80 employees. So, if a year-end participant count on one filing for a company that uses the long Form 5500 indicates 100 employees and the start-of-year participant count for the next year is 79, that is immediately suspicious. The DOL’s view might be that it is more likely that an employer is attempting to artificially lower participant count to avoid an audit than an employer lost so many employees on a holiday.

IRS Notices Related to the Form 5500

The IRS may send you notices related to your filing of the Form 5500. In the event that you receive a notice, you can review frequently asked questions on the IRS website for help understanding your notice and your next steps. 

Resources from Fisher 401(k) Solutions

From filings like the Form 5500 to the day-to-day activities of administering a 401(k) plan, it takes a lot of diligent work to keep a 401(k) plan in good working order. Find tips and helpful information about managing your 401(k) plan throughout our Resource Library.

¹https://www.irs.gov/retirement-plans/irs-penalty-relief-for-dol-dfvc-filers-of-late-annual-reports