It's still a tough economy out there, and many employers are trying to cut the cost of their 401(k) plans. The big news item has been the number of employers cutting back or eliminating their match.
But flying under the radar are those employers that are using the 401(k) plan to pay some or all of the cost of operating and administering the plan.
So let's start with ERISA fee basics. Plan assets can be used for two purposes: to pay benefits and pay the "reasonable" expenses of plan administration.
The decision to pay fees from the plan is a fiduciary decision subject to ERISA's fiduciary rules. That is, the plan must be established and maintained by the employer for the "exclusive benefit" of the employees and beneficiaries.
That means that the plan cannot pay for expenses that are considered to be the responsibility of the employer. These are called "settlor" expenses and may include:
* Legal or consulting services in connection with the formation of the plan.
* Plan design studies and cost projections to determine the financial impact of a plan change.
* Legal and consulting expenses incurred in connection with the decision to terminate a plan.
On the other hand, expenses that relate to the fiduciary's administration of the plan can be paid out of plan assets. These are called operational expenses and may include:
* Drafting required plan amendments to maintain the tax-qualified status of the plan, e.g., EGTRRA restatement.
* Discrimination testing.
* Implementing a plan termination.
Allocation of expenses
One of the matters that the regulatory agencies, the Internal Revenue Service and the Department of Labor, have addressed is how operational expenses should be allocated in a 401(k) plan, a defined contribution plan in which each participant has an individual account.
One method is to allocate expenses on a pro-rata basis. That is, expenses are allocated on the value of the assets in each participant's account. Thus, fees that are based on account balances, such as investment management fees, should be charged on this basis.
The other method is to allocate expenses on a per-capital basis. That is, each participant's account is charged with an equal dollar or percentage amount regardless of the value of the participant's account.
This may be used for fixed plan expenses such as legal, consulting, auditing and recordkeeping. In addition, certain transaction expenses payable by the plan can be charged directly to the account of the individual participant for whom it was incurred.
These transactional expenses can include fees related to hardship withdrawals, calculation of benefits payable under different options, benefit distributions, loan processing and annual administration, QDROs.
Reasonable plan expenses may be charged separately to the accounts of terminated employees, even though accounts for the active employees are not charged.
As with all things ERISA, there has to be proper documentation. Best practices would be to specifically state in the plan document that the plan may pay reasonable operating expenses, reflect that in the Summary Plan Description or Material Modification thereof, and have a written Expense Policy.
Here's an example taken from DOL "Guidance on Settlor v. Plan Expense." One hypothetical situation that the DOL discusses had the following expenses paid by the plan:
1. $50,000 to amend the plan to comply with tax changes.
2. $25,000 to amend the plan to establish a participant loan program.
3. $20,000 for routine nondiscrimination testing to ensure compliance with the tax qualification requirements.
Of all of the above expenses, if otherwise reasonable, which may be paid by the plan? Here's how the DOL answered:
The 50,000 to amend the plan to comply with tax changes and the $20,000 for routine nondiscrimination testing may constitute reasonable expenses of the plan.
The $25,000 to amend the plan to establish a participant loan program would be a plan design/settlor function and not a proper plan expense, since plan fiduciaries have no implementation obligations under the plan until such time as the plan is amended.
However, expenses involved with operating the established loan program would be implementation expenses to which the plan may pay reasonable expenses.
As you know, ERISA compliance matters are based on individual facts and circumstance, and especially when paying expenses from plan assets. So use caution when doing so.
Contributing Editor Jerry Kalish is the founder of The Retirement Plan Blog and president of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm. This discussion about plan expenses is for informational purposes only. Plan sponsors should always consult their legal counsel regarding the application of the plan expense rules to their specific situation.
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