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Thin(k) About Your 401(k) Plan: Paying Plan Expenses With Plan Assets…Not So Fast!

Lagniappe, which the Society of Louisiana Certified Public Accountants publishes nine times a year, asked our Fritz Gomila about using 401(k) plan assets to pay for plan expenses.  Below is Fritz’ article.

Click here for link to Lagniappe.

Paying Plan Expenses with Plan Assets…Not So Fast!

By: Fritz Gomila, Principal, ThirtyNorth Investments, LLC

During this period defined by closed businesses and stay at home mandates, many businesses are looking for ways to manage expenses including their approach to employee benefits.  Today, I want to focus on a matter that may be top of mind during the COVID-19 Pandemic – Plan Expenses.  As an Investment Advisor who works closely with retirement plans in a consultative manner, I urge you to learn more about this subject and to consider consulting an ERISA Attorney regarding expenses currently paid by or that you are considering paying with plan assets.  It is important to remember that Plan assets can only be used for two purposes:

  1. To pay benefits
  2. To pay reasonable administrative expenses of the plan

Using Plan assets to pay benefits is fairly straightforward, according to Michael Williams, a Partner at Phelps Dunbar LLP located in New Orleans.  However, when using Plan assets to pay reasonable administrative expenses, caution should be used.  According to Mr. Williams,

“Using Plan assets to pay administrative expenses is a fiduciary act governed by ERISA. First, Plan Sponsors and Plan Administrators should use the utmost care to make sure the administrative expenses are reasonable and necessary.  Secondly, Plan Sponsors and Plan Administrator must make sure the administrative expenses are fiduciary in nature and not settlor in nature.”

Fiduciary obligations can be complicated and are governed by law.  However, if you put your retirement plan clients’ interests first, you are definitely on the right track to thinking like a fiduciary.  As Michael said, the determination of whether or not an expense can be paid with plan assets often revolves around whether or not the decision or activity driving the expense is fiduciary or settlor in nature.  If the expense is fiduciary in nature, plan sponsors can pay with plan assets.  If settlor in nature, the opposite is true.

The Department of Labor (the government entity responsible for regulatory oversight in this space) offers guidance on settlor versus allowable plan expenses on its website (https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/advisory-opinions/guidance-on-settlor-v-plan-expenses):

“The department has taken the position that there is a class of activities which relates to the formation, rather than the management, of plans. These activities, generally referred to as settlor functions, include decisions relating to the formation, design and termination of plans and, except in the context of multi-employer plans, generally are not activities subject to Title I of ERISA.”

For example, expenses incurred when incorporating a mandatory plan amendment into the plan document are fiduciary in nature because the change is being made to maintain the plan’s qualified status.  However, a discretionary amendment to the plan document might be considered settlor in nature.  Some of the expenses generated when making a discretionary  plan amendment may not be allowed, but others may be ok.  The determination, again, depends upon whether or not the driver of the expense is fiduciary or settlor in nature.

The Department of Labor, has issued some guidance over the years on this topic.  Mr. Williams,

“While the guidance has not been as comprehensive as we would like, I think you can glean some basic principles.  Most ERISA lawyers feel fairly comfortable that basic administrative expenses can largely be paid from employee benefit plan assets, including those for plan recordkeeping and accounting, safekeeping of plan assets (i.e., custodial services), compliance auditing, legally required reporting (i.e., Form 5500), participant communications, and third party administrator (TPA) expenses (including start-up and ongoing fees).”

Another area that deserves attention is “but for” employee expenses.  A “but for” employee performs work for the plan that would not otherwise be required if a plan were not in place.  That employee does not have to be entirely dedicated to plan administration.  However, only the expenses that the employer incurs because of the employee providing services to the plan can be expensed to the plan.  For example, if an employee spends 20% of her time working on the plan, it would likely be disallowed to expense 100% of her salary.  Overhead expenses may not be expensed to the plan.  Plan sponsors must have thorough documentation to support paying for “but for” employee expenses with plan assets.  Mr. Williams cautions,

“The ‘but for’ test is more complicated than most employers realize.  There are strict rules in the DOL regulations governing this.  The DOL will look at these payments closely for two reasons.  One, there is an inherent conflict of interest as the employer is picking itself to provide the service over some other third party.  And two, proving that the employer would not have paid the employee ‘but for’ the services that employee provided to the Plan.  In small or medium sized enterprises where employees wear many hats, this might be a difficult standard to meet.”

When considering using plan assets to pay for plan expenses, plan sponsors should have a process in place to evaluate and document each decision.  Three key areas, among others, should be addressed and we recommend consulting with an ERISA attorney to help in the determination:

  1. Is payment of the expense allowed by the plan document (or at least does not prohibit it)?
  2. Is the expense related to a fiduciary activity rather than a settlor activity?
  3. Is paying the expense prudent and is the amount reasonable?

Determining whether or not the plan document allows or prohibits payment of an expenditure seems simple.  However, if a plan document simply does not prohibit the payment, plan sponsors may want to amend the language to specifically allow for the payment.  The difference between a fiduciary and a settlor activity can be tricky.  And, finally, documenting how you determine the reasonableness of the amount of the expense incurred is imperative when taking a fiduciary view on spending plan assets on expenses related to administering the plan.

Disclosures:

  • All expressions of opinion reflect the judgment of the author on the date of publication and are subject to change. It should not be regarded as a complete analysis of the subjects discussed. ERISA information is general in nature and should not be viewed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
  • ThirtyNorth Investments, LLC, is registered as an investment advisor with the SEC and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the advisor has attained a particular level of skill or ability. The firm is not engaged in the practice of law or accounting.

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