Let me introduce you to the “ERISA Account”, a relative newcomer to the small 401(k) plan market. It’s been part of the large and medium plan market for some time. Only recently has it migrated down stream because of (yes, you guessed it) the increased regulatory emphasis and fiduciary attention to fee disclosure.
ERISA Accounts are sometimes referred to as “ERISA Budget Accounts”, “ERISA Expense Accounts, “Expense Recapture Account”, or “Revenue Sharing Account”. We use the term ERISA Account because it succinctly describes the essence of what it is:
A plan level account that captures excess income collected by the recordkeeper that can be used to pay eligible plan expenses or even allocated to participants.
Let’s separate this discussion into its elements: 1) where the income comes from, and 2) how it can be used.
Where the Income Comes From
A mutual fund charges a fee that encompasses all the various fees that a participant is charged to invest in the particular fund. It’s usually referred to as the Expense Ratio. In addition to the management fee charged by the fund manager to manage the fund assets, the Expense Ratio may include:
- 12(b)(1) Fee: the fee paid by the mutual fund to a 401(k) provider or broker for including in it in the plan and servicing it after the sale.
- Sub Transfer Agent (Sub-TA) Fees: the fee paid by the fund when it subcontracts the participant accounting to transfer agents, e.g., bank or trust company, to execute, clear, and settle trades, and maintain shareholder ownership records. These organizations are called Sub-Transfer Agents.
- Provider Compensation: the fee paid by the fund to the service provider, sometimes referred to as Revenue Sharing, for administrative or contract owner or participant services provided on behalf of the fund.
The Expense Ration is usually stated as a percentage of assets under management, and is netted from mutual fund performance rather than being paid directly by the plan.
How the Income Can Be Used
At some point, the income received by the recordkeeper becomes excessive, i.e., more revenue that is needed to run the plan, and can be used to pay plan level expenses or reallocated to participants.
The expenses that can be paid by the plan are part of that ERISA basic: a fiduciary must “act for the exclusive purpose of providing benefits to plan participants and defraying reasonable expenses of administering the plan.”
The Department of Labor says that reasonable administrative expenses could include:
- Plan amendments required by change in law
- Plan amendments necessary to maintain tax qualified status
- Nondiscrimination testing
- Plan accounting
- Preparation of Form 5500
Plan assets, however, cannot be used for “Settlor Functions”, i.e., those expenses that are for the benefit of the employer. Settlor Expense could include:
- Studies of options for amending plan to maintain tax qualified status or for meeting new legal requirements
- Terminating plan
- Testing to explore plan design
- Union negotiations about plan provisions
The Department of Labor also permits participants to be charged for the reasonable cost of transactions attributable to individual participants, e.g., loans, QDROs, hardship withdrawals, calculations to determine benefits under various distribution alternatives, and benefit distributions.
Allocation to Participants
In addition to paying for reasonable plan expenses, funds in an ERISA Account may be reallocated to participant accounts pro-rata based on their account balances at the end of the year, or on a per capita basis. Note, however, that funds must be used by the end of the plan year. They cannot be rolled over to another plan year, or returned to the employer.
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.
Not all 401(k) plans will see excess income that can be used in an ERISA Account. However, as we move more into the “Age of Transparency”, expect to see ERISA Accounts more prevalent in the small plan market. And what’s a “small plan’? We’ve seen $1 million plans with ERISA Accounts.