Which pocket? A guide to paying retirement plan expenses out of plan assets
Any car owner can tell you that operating an automobile gives rise to a steady stream of expenses. Some of these expenses are necessary to ensure the car operates in a safe, effective, and legal manner (oil changes, replacement of worn tires and brakes). Other expenses are directed at enhancing the owner’s driving experience (satellite radio, upgraded sound system, remote start capability).
Retirement plans, too, bring with them a variety of expenses (as any plan sponsor can tell you). In the same way that some car-related expenses are necessary to ensure safe, legal operation, some of these plan-related expenses are necessary to ensure that the plan operates effectively and within the legal requirements of ERISA, the Internal Revenue Code (IRC), and their associated regulations. Some examples might be required participant notices, preparation of the annual Form 5500, and plan amendments required by new legislation. Other expenses, however, are incurred for the benefit of the plan sponsor rather than the plan’s participants. This type of expense might include accounting valuations used in plan sponsor financial statements or a cost analysis of changes to the plan’s benefit structure.
The car owner has little motivation to identify which category each operational expense belongs to, because all expenses will be paid out of the car owner’s personal funds. The retirement plan sponsor, however, may have the option to pay for some plan-related expenses out of the assets held in trust for the plan. This may seem like a more appealing option than paying for these expenses from business assets, but how does the sponsor determine which expenses are allowed to be paid from plan assets?
Settlor vs. non-settlor expenses
The payment of plan expenses is governed by the fiduciary rules of ERISA. Plan assets are to be used, per Section 404(a)(i)(A) of ERISA:
“for the exclusive purpose of:
- Providing benefits to participants and their beneficiaries; and
- Defraying reasonable expenses of administering the plan”
One concept that is helpful in this discussion is the difference between “settlor expenses” and “non-settlor expenses”. Settlor expenses are those expenses that are considered to benefit the plan sponsor rather than plan participants. (The “settlor” is the party that establishes a trust). In accordance with a plan sponsor’s fiduciary duties, settlor expenses should not be paid out of plan assets. Examples of settlor expenses include the following:
- Drafting the initial plan document
- Accounting valuations for the purpose of preparing the sponsor’s financial disclosures
- Discretionary plan amendments (amendments not required to maintain the plan’s tax-qualified status)
- Consulting related to a determination of whether to terminate the plan
Non-settlor expenses are those expenses that directly relate to the administration of the plan. Non-settlor expenses are permitted to be paid out of plan assets. Some examples of non-settlor expenses include the preparation or provision of the following:
- Annual actuarial valuation
- Form 5500 (and required schedules)
- Opinion from independent qualified public accountant (plan audit)
- Pension Benefit Guaranty Corporation (PBGC) comprehensive premium filing
- Participant recordkeeping services
- Benefit calculations
- Individual benefit statements for plan participants
- Required plan amendments (amendments necessary to maintain the plan’s tax-qualified status)
- Required participant notices (Annual Funding Notice, Summary Annual Report)
- Routine coverage or nondiscrimination testing
When deciding whether an expense can be paid out of plan assets, it is important to determine if the service being provided is primarily for the administration of the plan or if it is primarily for the benefit of the plan sponsor. Sometimes a change in the plan’s provisions or administration can involve both settlor and non-settlor expenses.
Interaction of settlor and non-settlor expenses
For example, consulting related to a plan sponsor’s decision to terminate a plan is a settlor expense. Likewise, the drafting of plan amendments necessary to terminate the plan is a settlor expense. The decision to terminate the plan is viewed as a business decision, and the amendment to terminate the plan is not required to ensure the plan’s qualified status under ERISA. However, once the termination has been approved and termination amendments have been adopted, the plan must be administered in accordance with those amendments. Consequently, the costs related to implementing the plan termination, such as filing with the PBGC, preparation of participant communications, processing of election forms, and conducting a search for an annuity provider, are non-settlor expenses and may be paid out of plan assets.
Sometimes, a required amendment may involve both settlor and non-settlor expenses. For example, in 2005, the IRS issued guidance on how plans could comply with a new final regulation providing that benefits with a value of more than $1,000 cannot be cashed out unless the participant makes an affirmative election to receive the cash. While plan amendments were necessary to comply with the final regulation, different options were available to bring a plan into compliance. A plan with a $5,000 cash-out limit could reduce the cash-out limit to $1,000, eliminating cash-outs for amounts exceeding $1,000. Alternatively, the plan could leave the $5,000 cash-out limit in place and come to an agreement with a default IRA service provider to receive cash-outs over $1,000 in cases where the participant did not make the required election. Any consulting related to deciding which option to implement would likely be considered a settlor expense, while the fees related to amending the plan in accordance with the chosen compliance method are likely a non-settlor expense.
Additional considerations
To pay plan expenses out of plan assets, the plan (or trust) document should allow for such payments. The U.S. Department of Labor (DOL), however, has generally been permissive on this issue, taking the position that when the plan document is silent regarding the payment of reasonable administrative expenses, the plan is permitted to pay such expenses.
As prescribed by ERISA, plan assets can be used to defray “reasonable” expenses of plan administration. Determination of whether a particular expense is reasonable is a fiduciary decision for the plan sponsor.
Payment of administrative expenses from plan assets in a defined contribution (DC) plan may effectively result in the plan participants paying those expenses, if those expenses are allocated against participant accounts. Expenses for a DC plan may also be paid out of a plan’s forfeiture account. Some DC plans may use an “ERISA Spend account” or a “revenue holding account” to record revenue-sharing payments from their investment providers. Non-settlor expenses could be paid from these accounts as well, preventing a charge against participant accounts. We recommend that plan sponsors document their procedures and policies regarding the payment of fees and the usage of forfeitures or “ERISA Spend accounts.”
In a defined benefit (DB) plan, the anticipated administrative expenses expected to be paid out of plan assets should be included in the target normal cost when calculating the minimum required contribution. If the plan is underfunded on a minimum contribution basis, the plan sponsor is effectively paying these expenses as part of the annual contribution. For an overfunded plan, paying permissible expenses out of plan assets may reduce the plan sponsor’s costs to maintain the plan.
The DOL has published “Guidance on Settlor v. Plan Expenses” to provide “further clarification and guidance” to “facilitate both compliance and enforcement efforts in this area”, available here:
The guidance presents six separate “fact patterns” followed by the DOL’s analysis of how the fiduciary duties under ERISA would be applied in each case.
Other sources of guidance include the DOL’s Advisory Opinion 2001-01A, DOL Field Assistance Bulletin 2003-3, and the Employee Benefit Security Administration’s publication “Understanding Retirement Plan Fees and Expenses.”
Finally, we suggest discussing any questions you have regarding the payment of retirement plan expenses with an ERISA attorney.