For many businesses, the moment a 401(k) plan requires an audit feels like an unexpected compliance cliff. One year your plan operates as a “small plan” with relatively simple Form 5500 filing requirements. The next year, you may suddenly face a full ERISA audit, additional administrative coordination, tighter deadlines, and audit fees that can easily exceed $10,000.
But here’s what many plan sponsors don’t realize:
There’s a built-in buffer called the 80/120 rule that can delay when your plan becomes subject to an audit requirement. And thanks to recent Department of Labor (DOL) rule changes, understanding this rule is more important than ever.
If your company sponsors a growing 401(k) plan and your participant count is approaching 100 employees, this rule could significantly impact your compliance strategy, budget, and audit timeline.
What Is the 80/120 Rule?
The 80/120 rule is a filing flexibility provision tied to Form 5500 reporting for employee benefit plans. In simple terms:
- Plans with fewer than 100 participants are generally considered “small plans” and usually do not require an independent audit.
- Plans with 100 or more participants are generally considered “large plans,” which typically triggers an annual ERISA audit requirement.
- However, plans with between 80 and 120 participants may continue using the prior year’s filing status instead of automatically switching between small and large plan status each year.
This prevents plans from constantly moving back and forth between filing categories because of normal employee turnover or seasonal workforce fluctuations.
Why the Rule Matters More After the DOL’s Recent Changes
Historically, many plan sponsors accidentally crossed the audit threshold because the participant count included eligible employees who never enrolled in the plan. But that changed beginning with 2023 plan years.
The DOL updated the counting rules for defined contribution plans like 401(k) and 403(b) plans. Now, for determining whether an initial audit is required, only participants with account balances are counted. Eligible employees who never enrolled and have no balance are excluded.
This is a major shift for growing employers. For example:
- A company may have 140 eligible employees.
- But if only 92 employees actually have account balances, the plan may still qualify as a small plan.
- That can delay the audit requirement for years.
For businesses implementing automatic enrollment under the expanding requirements of the SECURE 2.0 Act, this distinction has become even more important because participation rates are increasing across many plans.
How the 80/120 Rule Actually Works
Scenario 1: Your Plan Filed as a Small Plan Last Year
If your plan filed as a small plan last year:
- You can generally continue filing as a small plan as long as participant counts remain below 120.
- Once you exceed 120 participants with account balances at the beginning of the plan year, the audit requirement usually begins.
Example
| Plan Year | Participants With Balances | Filing Status |
|---|---|---|
| 2025 | 78 | Small Plan |
| 2026 | 94 | Still Small Plan |
| 2027 | 117 | Still Small Plan |
| 2028 | 121 | Large Plan + Audit Required |
This flexibility band is why the rule is commonly called the “80/120 rule.”
Scenario 2: Your Plan Already Files as a Large Plan
Once a plan becomes a large plan and starts requiring audits, moving back to small-plan status is less common and requires careful analysis.
Many sponsors assume they can stop auditing once headcount drops. In reality, there are additional considerations involving filing history, participant counts, and DOL rules.
That’s why plan sponsors should never assume an audit is no longer required without consulting an experienced ERISA audit firm.
Common Misunderstandings About the 80/120 Rule
Myth #1: “100 Employees Automatically Means an Audit”
Not necessarily. The key number is not total employees. It’s generally participants with account balances at the beginning of the plan year for determining an initial audit requirement.
Myth #2: “Every Eligible Employee Counts”
Not anymore for initial audit determination purposes. Employees who are eligible but never enrolled and do not have balances are generally excluded from the count under the revised rules.
Myth #3: “If We Cross 100 Participants, We Immediately Need an Audit”
Not if the plan qualifies under the 80/120 rule and previously filed as a small plan. Many businesses can continue avoiding audits until they exceed 120 participants.
Strategic Planning Opportunities for Plan Sponsors
The 80/120 rule isn’t about avoiding compliance. It’s about understanding your filing position early enough to plan strategically.
Monitor Participant Counts Early
Don’t wait until Form 5500 season. Your January 1 participant count can determine whether an audit is required for the entire plan year.
Coordinate With Your TPA and Auditor
Your third-party administrator (TPA), payroll provider, and audit firm should all be aligned on:
-
Participant counting methodology
-
Account balance status
-
Filing classification
-
Audit readiness timelines
Miscommunication here can create expensive surprises late in the year.
Encourage Small Balance Rollovers
One often-overlooked strategy involves terminated employees with small remaining balances. Cleaning up inactive participant balances may help reduce counts and delay the large-plan threshold.
What Happens When Your Plan Finally Requires an Audit?
For many businesses, the first-year audit is the hardest because processes aren’t established yet. Plan sponsors often encounter:
- Significant document requests
- Time-consuming census corrections
- Contribution reconciliation issues
- Eligibility testing errors
- Loan and distribution compliance reviews
- Delays caused by inexperienced audit teams
This is where specialization matters. At PriceKubecka, our dedicated EBP audit team performs hundreds of retirement plan audits annually using a streamlined, technology-driven process designed to minimize disruption for plan sponsors. Our approach includes:
- Flat-fee pricing with no surprise scope creep
- Senior-led audit teams
- Full-population testing
- Secure, fully remote audit processes
- A streamlined experience that often requires less than five hours of sponsor time
For plan sponsors approaching the audit threshold, proactive planning can make the transition significantly smoother.
Final Thoughts from a 401(k) Auditor
The 80/120 rule gives growing businesses important flexibility when navigating 401(k) audit requirements. But the rule is also frequently misunderstood.
With participant counting rules changing, SECURE 2.0 expanding retirement plan participation, and DOL scrutiny continuing to increase, plan sponsors should understand exactly where their plan stands long before Form 5500 deadlines arrive.
If your plan is approaching the audit threshold, Contact Our Audit Experts now to evaluate your participant counts, filing status, and audit readiness strategy.
Frequently Asked Questions
What is the 80/120 rule for 401(k) audits?
The 80/120 rule allows plans with between 80 and 120 participants to continue using the prior year’s filing status instead of switching between small-plan and large-plan filing each year.
When does a 401(k) audit become mandatory?
Generally, a plan audit becomes mandatory when the plan files as a large plan. Under current rules, defined contribution plans typically require an initial audit once they exceed 120 participants with account balances at the beginning of the plan year.
Do employees who never enrolled in the 401(k) count toward the audit threshold?
For determining whether an initial audit is required, eligible employees without account balances are generally excluded under the updated DOL rules.
What should employers do if they are close to 120 participants?
Plan sponsors should:
- Review participant counts early
- Coordinate with their TPA
- Confirm filing status
- Prepare for audit timing and document requests
- Consult with an experienced EBP audit firm before the deadline season begins
Why is working with a specialized EBP audit firm important?
Specialized firms understand ERISA rules, participant counting nuances, DOL expectations, and efficient audit workflows. Inexperienced firms often create unnecessary delays, extra requests, and unexpected fees.
