That’s the question employers ask regarding who pays 401(k) fees. The “us” being, of course, the employer, and the “them” being the plan participants.
The number of “thems” has been increasing. According to Deloitte’s 2015 Annual Defined Contribution Benchmarking Survey, the number of employers completely covering the cost of fees declined again in 2015 to 36% compared to 40% in 2013-14 and 50% in 2012.
Whether you are an employer whose employees are already paying some or all of the plan costs, or are considering doing so, here are some important considerations to keep in mind.
The ERISA Basics
Plan assets can be used for two purposes: to pay benefits and pay the “reasonable” expenses of plan administration.
The decision to pay fees from the plan is a fiduciary decision subject to ERISA’s fiduciary rules. That is, the plan must be established and maintained by the employer for the “exclusive benefit” of the employees and beneficiaries.
That means that the plan cannot pay for expenses that are considered to be the responsibility of the employer. These are called “settlor” expenses and may include:
- Legal or consulting services in connection with the formation of the plan
- Plan design studies and cost projections to determine the financial impact of a plan change
- Legal and consulting expenses incurred in connection with the decision to terminate a plan
On the other hand, expenses that relate to the fiduciary’s administration of the plan can be paid out of plan assets. These are called operational expenses and may include:
- Drafting required plan amendments to maintain the tax-qualified status of the plan, e.g., Pension Protection Act restatement
- Discrimination testing
- Implementing a plan termination
It’s more complicated than this, of course. The Department of Labor (“DOL”) has published Guidance on Settlor vs. Plan Expenses that provides a set of six hypothetical fact patterns in which various plan expense issues are both presented and addressed.
Allocation of Expenses
What about those plan expenses that are not being charged to a specific participant’s account such as transaction fees? Those operational fees can be allocated to all plan participants on either a “pro rata”, done proportionately based on account balances; or “per capita”, each participant pays the same amount.
Here’s a example of how a fee of $1,000 would be allocated either pro rata or per capita:
As you can see the participant with the largest account balance would pay the most fees under the pro rata method and the participant with the smallest account balance would pay the same fee as the others under the per capita method.
Which method is best? Once again, it’s based on fact and circumstances as to what is reasonable. 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.
Using Forfeitures to Pay Expenses
Forfeitures, those amounts arising from participants terminating whose accounts are not fully vested, can be used to pay expenses or reduce employer contributions. In the case of the latter, however, the type of employer contribution should be taken into account. For example, forfeitures from matching contribution should be used to reduce matching contributions and forfeitures from employer contributions should be used to reduce profit sharing contributions.
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.
As you know, ERISA compliance matters are based on individual facts and circumstance, and especially when paying expenses from plan assets. So use caution when doing so including discussing it with your legal advisor.