Qualified retirement plans
provide tax deductible benefits for employers and employees, as well as an
opportunity for significant savings for the post-retirement years. But these
plans require adherence to numerous governmental regulations, and there are
costs involved in the establishment and ongoing maintenance of the plan.
The list of expenses includes the preparation of plan documents,
recordkeeping and government reporting, to name just a few. It is important
that these functions be carried out by trained professionals who are
familiar with the Internal Revenue Service (IRS) and Department of Labor
(DOL) rules and regulations for qualified plans.
Many of these expenses are permitted to be paid from the assets of the
plan, although certain expenses must be paid by the sponsoring employer. In
hard economic times, employers who have been footing the bill for
administrative expenses may choose to reconsider and have some of the fees
paid from the plan assets.
Expenses Borne By Employer
The DOL does not permit expenses which relate to "settlor functions" to
be paid from the plan assets. A "settlor function" is an independent
business activity or decision of the employer. These activities are thought
to primarily benefit the employer.
Expenses such as the following cannot be paid from plan assets, although
they are deductible as ordinary business expenses:
- Plan design expenses, such as studies of the plan's feasibility and
projections;
- Preparation of the initial plan document;
- Preparation of voluntary plan amendments (required amendments due to
law changes may be paid from plan assets); and
- Certain plan termination fees.
Example: The XYZ Company established a 401(k) plan effective January 1,
2006. The cost for preparation of the documents to establish the plan is a
business expense that must be paid by the employer and not the plan. In 2009
the company was informed that the plan had to be restated for EGTRRA (the
Economic Growth and Tax Relief Reconciliation Act) which was enacted in 2001
and other laws that were passed since that time. Because the restated
document is required by a change in the law and not a voluntary amendment
instituted by the employer, the restatement fee can be charged to
participants' accounts under the plan if the employer chooses not to pay
that cost.
Administrative Expenses Payable From Plan Assets
If the employer wishes, fees related to the administration of the plan
can generally be paid by the plan if they are prudent and reasonable and
permitted under the plan document. Reasonable administrative costs that may
be charged to plan participants include the following:
- Participant recordkeeping;
- Nondiscrimination and top heavy testing;
- Preparation and distribution of benefit statements;
- Preparation of Form 5500 and schedules;
- Accountant's audit report required for large plans (those with over
100 participants);
- Summary Annual Reports;
- Notices for automatic enrollment, default investments and safe harbor
401(k) plans (where applicable);
- Expenses for computing benefit payments and processing loans;
- Plan amendments/restatements required by law changes or new
regulations;
- IRS determination letter requests;
- Purchase of trustees' fidelity bond;
- Trustee fees;
- Investment management fees; and
- Fees to process participant enrollment and investment elections.
One issue to consider when deciding if a fee should be paid from the plan
assets is the size of the plan relative to the amount of the fee. Allocating
a $1,500 fee among 100 participants with total plan assets of $1,000,000
will have much less of an impact than if the plan has only 10 participants
with assets of $100,000.
The employer, as a fiduciary of the plan, is required to monitor plan
expenses to insure that they are reasonable and prudent.
Allocation Methods
Once it's been established that a fee can properly be paid by the plan,
the method of allocating the fee must be determined. There are several
alternatives outlined below.
Allocate Fee to Specific Participant
The fairest method for allocating certain service fees is to charge them
against the account of the participant involved in the transaction or
service, although such fees can be allocated to the entire plan.
Participants should be informed of the amount of the fee in advance. The
following fees are typically charged to the affected participant's account:
- Fees to prepare distribution election and consent forms;
- Hardship withdrawal expenses;
- Fees to prepare participant loan documents and the annual loan
administration expenses; and
- Qualified Domestic Relation Order (QDRO) determination and processing
fees.
Pro Rata or Per Capita Allocation
Plan expenses that are not being charged to a specific participant's
account can be allocated to all plan participants on either a "pro rata" or
a "per capita" basis.
A pro rata allocation is done proportionately based on account balances.
Per capita means that the amount is allocated equally based on the number of
participants in the plan. Here is an example of how a $1,000 fee would be
allocated under each method:
| A |
$60,000 |
$600 |
$250 |
| B |
20,000 |
200 |
250 |
| C |
15,000 |
150 |
250 |
| D |
5,000 |
50 |
250 |
| Total |
$100,000 |
$1,000 |
$1,000 |
As you can see, the participant with the highest account balance would
have the largest fee deducted under the pro rata method.
DOL rules require that the allocation method chosen be prudent and solely
in the interest of all participants. It must have a rational basis, with
some reasonable relationship to the services provided. It may be more
appropriate to allocate certain investment fees pro rata based on account
balances, while some administrative fees may be more appropriately allocated
per capita, where each participant pays the same amount. It depends on the
facts and circumstances of each situation, with prudence and reasonableness
being the primary considerations.
The DOL has stated that it could be reasonable to treat terminated
employees differently than active employees when it comes to the allocation
of plan expenses. This may be more easily justified where the terminated
employee had a choice and elected to remain in the plan, as compared to the
situation where terminees cannot receive a distribution until reaching
normal retirement age.
Using Forfeitures to Pay Expenses
Some plans provide that allowable expenses may be paid from the
forfeiture account (accumulated from employees who terminated employment
without full vesting). The impact that this will have depends on how
forfeitures are treated under the terms of the plan. If forfeitures are used
to offset employer contributions, such as matching contributions in a 401(k)
plan, it's as if the employer were paying the expense because the reduced
forfeitures will likely result in additional employer contributions. But if
the forfeitures are allocated to remaining participants, then it's as if the
participants are paying the fee, due to the reduced forfeiture allocation.
Defined Benefit Plans
Defined benefit plans may also pay expenses from plan assets, but
participants' benefits will not be reduced as a result. That's because the
benefits are stipulated under the terms of the plan, and paying expenses
from the plan would only reduce the assets available to pay benefits, which
could increase the employer's funding obligation. However, where investments
have outperformed actuarial assumptions creating overfunding, paying
expenses from the plan may be desirable.
Plan Document and Disclosure Requirements
Expenses may only be paid from the plan assets if the plan document
authorizes plan expense payments or is silent on the payment of expenses.
The document may contain specific details for the payment and allocation of
plan expenses, although it is not required to provide such detail. Plan
documents that specifically prohibit the payment of expenses by the plan may
be amended prospectively to remove this provision and allow the plan to pay
expenses in the future. However, the expenses of this amendment must be paid
by the employer as a voluntary amendment.
Participants need to be informed if plan expenses can be deducted from
their accounts. Such information should be included in the Summary Plan
Description (SPD) which is required to be distributed to each employee upon
entering the plan. Specific details including the amount of and method for
allocating the various types of expenses should be included.
DOL Proposals
Last year the DOL proposed fiduciary disclosure requirements for
participant-directed accounts which would require additional information to
be provided about investment options and more detailed information about
fees. The rules were supposed to have been effective January 1, 2009, but it
is now uncertain when, or if, this regulation will be finalized.
Another DOL proposed regulation concerns the contracts or arrangements
between the plan fiduciary and a service provider. Under the proposal, in
order for a service provider's fee to be paid by the plan without resulting
in a prohibited transaction, the contract must be in writing and disclose
the fees to be paid. In addition, the service provider must disclose any
relationship it has with other parties that could create a conflict of
interest.
Although it is unclear when, or if, this regulation will be finalized, it
may be advisable to adhere to a service provider disclosure policy to
prevent violations of the fiduciary and prohibited transaction rules under
ERISA.
One DOL change that has been finalized is the increased reporting of fees
paid to service providers on Schedule C of Form 5500 for large plans,
effective for plan years beginning in 2009.
Conclusion
Employers have the option of paying certain expenses of a qualified plan
from the business or from the assets of the plan, in which case the plan
participants share the burden of such costs. The DOL has provided rules to
determine which expenses may be paid by the plan and the allowable
allocation methods among participants' accounts.
The plan document must allow the plan to pay reasonable expenses in order
for it to take place, and the expense policy must be communicated to
employees through the SPD. Recent DOL proposals seek to increase disclosure
of plan expense information to participants, fiduciaries and the DOL.
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