Making Your Retirement Plan Pay for Itself
A well-run retirement plan can provide employers with many advantages, including a current tax deduction for contributions to the plan, a mechanism by which to defer the payment of income taxes for the employer and their employees, and a spendthrift trust that is safe from creditor claims. However, these benefits come at some expense. A few of the expenses that an employer will incur in relation to its retirement plan include: (1) the cost of designing and implementing the plan; (2) investment management or trustee fees; and (3) reporting and disclosure expenses. Most often, employers pay these expenses from their business accounts and deduct them as ordinary and necessary business expenses. However, in today’s economic climate, some employers who are looking for a way to cut costs are now asking if there is a way to make their retirement plan “pay for itself” by charging plan-related expenses directly against plan assets.
Under the Employee Retirement Income Security Act of 1974 (“ERISA”), employers can pay from plan assets the “reasonable expenses of administering the plan.” However, employers should tread carefully when determining which expenses are payable from plan assets. This is because the selection of expenses to be paid by the plan is a fiduciary function, and carries with it corresponding fiduciary liability. In fact, the issue of whether the payment of expenses from plan assets is proper is commonly explored on audit by both the Internal Revenue Service and the U.S. Department of Labor (“DOL”) (i.e., the two governmental agencies charged with regulating retirement plans).
DOL has issued piecemeal guidance to help employers determine which expenses are payable from plan assets, and thereby avoid fiduciary liability. In general, if an employer wishes to charge the plan for an expense, the expense must be: (1) authorized under the terms of the plan document; and (2) a “proper” expense eligible for payment from the plan. DOL has clarified the meaning of a “proper” expense by differentiating between “settlor” and “administrative” expenses. Only administrative expenses that are reasonable are considered “proper” expenses for payment by the plan.
Expenses incurred for performing settlor functions can never be paid from plan assets because settlor functions are not considered fiduciary activities. Some examples of settlor functions include the initial design of the plan, preparation of the initial plan document, and implementation of optional plan amendments. If an employer pays these types of expenses from plan assets, the employer has engaged in a prohibited transaction and will be subject to penalties and excise taxes on the transaction.
Since administrative functions are necessary for the ongoing maintenance of the plan expenses incurred in plan administration can be paid from plan assets, provided the expenses are reasonable. Such administrative functions include plan accounting and testing, providing participants with required disclosures and notices (such as Summary Plan Descriptions and individual benefit statements), and preparing the plan’s Form 5500 filing. Furthermore, expenses to keep the plan in compliance with applicable laws and regulations, such as “good faith” amendments or plan restatements, may be paid from plan assets.
Although employers can pay reasonable administrative expenses from plan assets, the expenses must be allocated equitably among plan participants. DOL favors a “pro-rata” allocation formula when paying plan expenses from plan assets. Under the pro-rata formula, all participants pay their portion of the expense in proportion to their account balance in the plan. Therefore, participants with the largest account balances pay a greater dollar amount of the expense.
In addition to the pro-rata formula, DOL has indicated that a plan may, under some circumstances, charge each plan participant an equal dollar amount for an expense, provided that the expense is a fixed administrative expense. This is known as the “per capita” method of allocating plan expenses. Fixed expenses that may be paid using the per capita method include annual fees for recordkeeping, auditing, or preparing the plan’s Form 5500. However, employers should use this allocation method only if all participants in the plan have similar account balances to avoid allocating a disproportionate amount of the expense to participants with smaller account balances.
Finally, DOL allows employers to charge a specific participant’s account for administrative expenses incurred solely as a result of that individual participant’s actions. Common examples of expenses that can be charged to an individual participant’s account include loan or hardship withdrawal fees, distribution fees, and fees related to the preparation or implementation of a Qualified Domestic Relations Order. In addition, DOL has recently issued guidance that makes it clear that an employer can charge terminated for maintaining their accounts in the plan following termination of employment, even if the employer does not impose a similar account maintenance fee upon actively-employed participants.
If you have questions or concerns regarding which plan expenses can be paid from plan assets or if an individual participant can be charged for a plan expense, please contact a member of the firm’s Employee Benefits Group.