What Is an Eligibility Audit in a Defined Benefit (DB) Retirement Plan?

Created by Kelly Knudsen, Modified on Thu, 5 Sep at 1:16 PM by Kelly Knudsen

An eligibility audit in a defined benefit (DB) retirement plan is an essential tool for ensuring that your retirement plan is compliant and financially sound. Defined benefit plans provide employees with guaranteed benefits based on a formula that considers factors like tenure and salary. An eligibility audit ensures that all participating employees meet the specific qualifications outlined in the plan, such as age and length of service. This process is crucial for preventing financial mismanagement and ensuring only qualified employees are receiving or accruing benefits [1] [2].

Why Conduct an Eligibility Audit?

There are several reasons to conduct regular eligibility audits. First, these audits help employers verify that the employees enrolled in the plan are properly classified, ensuring that only eligible employees participate. Misclassifying employees, such as enrolling part-time or temporary workers who haven’t met the eligibility criteria, can increase plan costs and affect the accuracy of plan liabilities [3] [4]. Regular audits allow employers to stay compliant with regulatory standards, such as those set by the Employee Retirement Income Security Act (ERISA), and avoid costly penalties or disqualification of the plan [5].

The audit also helps identify and correct administrative errors, such as incorrect service crediting or compensation calculations, that can impact a participant's future benefits. Identifying these issues early can help protect the financial health of the plan and ensure participants receive their correct benefits [6].

Common Issues Uncovered by an Eligibility Audit

Eligibility audits frequently uncover issues such as:

Employee Misclassification: This includes improperly classifying part-time or temporary workers as eligible for benefits, even if they have not met the plan’s criteria.
Incorrect Compensation Calculations: Defined benefit plans often use specific types of compensation (e.g., base salary) in their formulas. Including additional forms of pay, such as bonuses, could inflate benefit amounts and add unnecessary cost to the plan [2] [7].
Failure to Remove Terminated Employees: Occasionally, former employees may remain in the plan and continue to accrue benefits after termination, which could affect the plan’s financial obligations [4].

Audits that catch these issues early allow plan sponsors to make corrections without causing major disruptions or requiring expensive corrections down the road [8].

Best Practices for Conducting an Eligibility Audit

Eligibility audits should be conducted regularly, ideally annually. During the audit, employers should focus on:

Reviewing Employee Data: Cross-check personnel files, payroll data, and employment contracts to ensure compliance with the plan's eligibility rules [2].
Reviewing Plan Documents: Compare current plan operations with the official plan documents to confirm that eligibility criteria are being enforced as written [9].
Engaging Third-Party Experts: For complex or large DB plans, it can be helpful to engage third-party auditors who specialize in employee benefit plan audits to ensure thoroughness and objectivity [3].

Ensuring these audits are a part of your regular fiduciary process helps avoid costly errors and regulatory issues.

Benefits of Regular Eligibility Audits

Routine audits provide substantial benefits, including:

Financial Integrity: They ensure that only qualified employees are enrolled, which helps maintain accurate liabilities and prevents unnecessary plan expenses [1] [7].
Regulatory Compliance: Regular audits ensure your plan complies with ERISA and IRS rules, helping you avoid penalties and maintaining the plan’s tax-qualified status [4] [5].
Long-Term Sustainability: By verifying participant eligibility and correcting errors early, eligibility audits contribute to the long-term sustainability of the plan [6].

Conclusion

An eligibility audit in a DB retirement plan is a proactive step that employers should take to ensure compliance, financial stability, and accurate benefit distribution. Regular audits not only protect the plan sponsor from costly mistakes but also ensure that the plan operates in a fair and efficient manner, safeguarding the retirement future of eligible employees.

References:

[1] RSM US. (2024). Retirement plan audit and contribution considerations. Retrieved from https://rsmus.com/insights/services/business-tax/retirement-plan-audit-and-contribution-considerations.html

[2] Schneider Downs. (n.d.). ERISA frequently asked questions. Retrieved from https://schneiderdowns.com/erisa-frequently-asked-questions/

[3] Eide Bailly. (2023). Audit requirement change for employee benefit plans. Retrieved from https://www.eidebailly.com/insights/alerts/2023/9/audit-requirement-change-for-employee-benefit-plans

[4] Warren Averett. (n.d.). Employee benefit plan audits: What you need to know. Retrieved from https://warrenaverett.com/insights/guides/employee-benefit-plan-audits/

[5] RSM US. (2023). SECURE 2.0: Considerations to achieve your workforce and business goals. Retrieved from https://rsmus.com/insights/services/business-tax/secure-2-considerations-to-achieve-workforce-goals.html

[6] RSM US. (2021). Why internal controls are important to benefit plans. Retrieved from https://rsmus.com/insights/services/financial-reporting/internal-controls-benefit-plans.html

[7] Doeren Mayhew. (n.d.). Employee benefit plan audits: What you need to know and when you need one. Retrieved from https://doeren.com/viewpoint/employee-benefit-plan-audits-what-you-need-to-know-and-when-you-need-one

[8] RSM US. (2021). Performing a 401(k) retirement plan self-checkup. Retrieved from https://rsmus.com/insights/services/financial-reporting/performing-a-401k-retirement-plan-self-checkup.html

[9] RSM US. (2023). New audit rule impacting employee benefit plans. Retrieved from https://rsmus.com/insights/alerts/2023/10/new-form-5500-rule-impacting-employee-benefit-plan-audit.html