Phil Pavarini is a licensed insurance producer and is compensated when a bond is placed through this site. This page is general information, not legal, tax or fiduciary advice, and it is not a substitute for reading your plan document or contract or for advice from your own counsel. Figures shown are current as of the date on this page.
Everything else in this section is about ERISA section 412. This page is about a different rule that also produces a bonding requirement, sits in a completely different part of the regulations, and can demand a bond many times larger than section 412 does.
It comes from 29 CFR 2520.104-46, the regulation that lets a small plan skip the independent audit. The waiver is conditional, and one of the conditions is a bond.
The rule in one paragraph#
A plan with fewer than 100 participants can generally avoid the independent qualified public accountant’s audit. To use the waiver, either at least 95 percent of plan assets must be qualifying plan assets, or every person who handles the non-qualifying assets must be bonded in an amount at least equal to the value of those non-qualifying assets.
Read that second branch twice. It is not 10 percent. It is 100 percent of the non-qualifying assets, and it is measured against the full value of them, not against the amount by which they exceed the 5 percent threshold.
What counts as a qualifying asset#
Qualifying plan assets, broadly, are the things held somewhere regulated and reported on:
- Assets held by a bank or similar financial institution, an insurance company, a registered broker-dealer, or an IRA trustee.
- Shares of a registered investment company, meaning ordinary mutual funds.
- Insurance contracts issued by a regulated insurer.
- Qualifying employer securities as defined in ERISA section 407(d)(5).
- Participant loans meeting the requirements of section 408(b)(1).
- Assets in a participant-directed individual account where the participant controls the investments and receives an annual statement from a regulated institution.
For an ordinary bundled 401(k) at a large recordkeeper, essentially everything is qualifying and this rule never comes up. That is why most sponsors have never heard of it.
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What is non-qualifying, and where it shows up#
Anything outside that list. In practice:
- Real estate held directly by the plan.
- Mortgages and promissory notes other than qualifying participant loans.
- Limited partnership and LLC interests, including many private funds.
- Private company stock that is not qualifying employer securities.
- Precious metals, cryptocurrency and other assets not held by a regulated institution.
- Artwork, equipment and other tangible property.
This is the self-directed corner of the market. A small plan that moved 30 percent of its assets into a rental property or a private fund has walked into this rule, almost always without being told.
A worked example, because the arithmetic is startling#
A plan has $900,000 in total assets. Of that, $300,000 is a directly held rental property and $600,000 sits in mutual funds.
Section 412 says: 10 percent of $900,000, so a $90,000 bond.
The audit waiver says: non-qualifying assets are 33 percent of the plan, well over 5 percent, so to use the waiver the people handling that property must be bonded for at least $300,000.
The plan needs the larger figure to avoid the audit. And note the alternative: the plan can carry the $90,000 bond and simply have the audit instead. An audit on a small plan generally costs several thousand dollars a year. The bond does not. For most plans in this position the bond is the cheaper path by a wide margin, but it is a genuine choice and it should be made deliberately rather than discovered.
The disclosure that comes with it#
Using the waiver also carries a disclosure obligation. The administrator has to tell participants, in the summary annual report or separately, the name of each regulated institution holding qualifying assets and the amount held, the name of the surety company if the bond route is being used, and that participants may examine, or receive copies of, evidence of the bond and the statements from those institutions without charge.
That last part is the one to sit with. A participant can ask to see the bond. If the plan has been relying on the waiver while carrying only the section 412 amount, that request produces the problem in writing.
Common questions
What are non-qualifying plan assets?
Assets not held by a regulated institution and not on the qualifying list: directly held real estate, mortgages and notes other than qualifying participant loans, limited partnership and LLC interests, private company stock, precious metals and cryptocurrency not held by a regulated institution, and tangible property such as equipment or artwork.
How much bond do non-qualifying assets require?
At least 100 percent of their value, for each person who handles them, if the plan wants to use the small plan audit waiver. This is completely separate from the section 412 calculation and is usually the much larger number. It is measured against the full value of the non-qualifying assets, not against the excess over 5 percent.
Does this apply to a normal 401(k) at a big recordkeeper?
Almost never. Mutual funds, insurance contracts, assets held at a bank or broker-dealer and qualifying participant loans are all qualifying assets, so a standard bundled plan is at or near 100 percent qualifying and the rule never engages.
Can we just have the audit instead of the bigger bond?
Yes, that is the actual choice the regulation gives you. The 100 percent bond is a condition of the audit waiver, not a freestanding requirement. But an independent audit on a small plan typically runs into the thousands of dollars annually, and the additional bond usually does not, so the bond is the cheaper route for most plans in this position.
Do participants have to be told about this?
Yes, if the plan relies on the waiver. The administrator must disclose the regulated institutions holding qualifying assets and the amounts, name the surety company where the bond route is used, and tell participants they may examine or obtain copies of the bond and the institutional statements without charge.
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