ERISA Plan Expenses: When Can The Plan Pay The Tab?

Plan sponsors can pay ERISA plan expenses themselves or, under certain circumstances, from plan assets. Understanding what costs can be expensed to the plan — and which expenses should come out of the employer's piggy bank — can be complex. This article provides a guide to assess whether expenses can be paid with plan assets and key considerations for plan fiduciaries about the use of plan assets for expenses.

ERISA Legal Framework

Under ERISA Section 404, a plan must be maintained for the exclusive benefit of plan participants and their beneficiaries. This rule is commonly known as ERISA's "exclusive benefit rule," and it prohibits employers from diverting assets for the employer's own benefit. Like most rules, there are exceptions to the exclusive benefit rule, including the use of plan assets to pay reasonable plan expenses. Although a plan's payment of expenses is not a benefit to participants, it is permissible under the exclusive benefit rule if the expenses are reasonable and relate to the administrative or fiduciary operations of the plan.

The Department of Labor (DOL) divides expenses into those that are of a fiduciary or administrative nature and those that are "settlor" functions, meaning expenses incurred as part of the employer's role as the settlor of a trust. Administrative expenses can either be paid by the plan or by the employer. While, on the other hand, settlor expenses must be paid by the employer and should never be paid by plan assets.

What Expenses Are Plan Payable?

Determining which expenses the plan can pay requires careful analysis in light of ERISA provisions and DOL guidance. Below is a table outlining common expenses and whether they can be paid by the plan under ERISA.

Allocating Plan Expenses to Participant Accounts (Read the Plan Document!)

Generally, plan sponsors have considerable discretion in determining how plan payable expenses will be allocated. However, if the plan document addresses how certain expenses are allocated, the plan administrator is required to follow the plan document. If the plan document is silent or ambiguous, the plan administrator must select the appropriate allocation method.

The allocation method must be prudently determined and should weigh the competing interests of various classes of participants and the effects of various expense allocation methods on those interests. The plan administrator does not fail to act in the best interest of plan participants merely because the expense allocation method disfavors one class of participants, provided that there is a rational basis for selecting the allocation method.

The allocation method that a plan administrator uses largely depends on how the expense is charged to the plan and the reason for the expense. There are three primary ways of allocating fees to a defined contribution plan, such as a 401(k) plan: (i) pro rata, (ii) per capita, or (iii) based on participant usage.

• Pro Rata Method – The pro rata method is usually the most equitable allocation method. The expenses are allocated to participant accounts based on each participant's account balance. For example, if investment-related fees are calculated based on account balances, then the plan administrator should allocate those fees using the pro rata method.
• Per Capita Method– The per capita method, whereby an expense is evenly divided amongst plan participants, can be a reasonable allocation method for fixed administrative expenses, such as recordkeeping fees. For example, if the plan is charged a third-party service fee based on the number of participants, it would be reasonable to allocate those fees on a per capita basis.
• Participant Usage – As the DOL explained in Field Assistance Bulletin 2003-3, certain expenses can be charged to individual participant accounts based on usage. For example, a plan could charge individual participant accounts when the plan incurs a fee for processing a hardship withdrawal, participant loans, a distribution election, or for expenses relating to determination of whether a domestic relations order is a qualified domestic relations order under ERISA (i.e., a QDRO).

Notably, DOL regulations require the summary plan description (SPD) to include a summary of any provisions that may result in the imposition of a fee or charge on a participant's account, the payment of which is a condition to the receipt of benefits. The SPD must include a statement identifying the circumstances that may result in the offset or reduction of any benefits that a participant or beneficiary might otherwise reasonably expect the plan to provide on the basis of the description of benefits. If the fees are subject to change, the SPD can refer the participants to the other fee disclosures, such as investment fee disclosures. In addition, if the plan charges individual participant accounts for QDRO determinations, the QDRO procedures and SPD must explain that individual participant's accounts will be charged. For additional SPD requirements and recommendations, see 401(k) Compliance Check #10: Magic Words – Best Practices for 401(k) Plan SPDs.

Note on Recent Forfeiture Account Litigation

Over the past few years, there has been increasing litigation relating to how plan sponsors use their plan's forfeiture account. Generally, a forfeiture account, which includes the non-vested portion of a former employee's account balance after five consecutive one-year breaks in service, may be used to pay plan expenses, reduce employer contributions, or increase employer contributions. The plan sponsor must decide how to use the forfeiture account balance before the end of the plan year in which the forfeiture occurred or the year following the year in which they occur.

Most plan documents include language describing how plan sponsors can use the forfeiture account balance. The plan document either requires forfeitures be used in a certain manner (e.g., used to offset plan fees) or gives the plan administrator discretion to decide how the forfeiture account will be used (e.g., may be used to offset employer contributions or reduce plan fees). In recent cases, plaintiffs have argued that — when the plan document gives the plan administrator discretion — the plan administrator breaches its ERISA fiduciary duties when it uses the forfeiture account to offset employer contributions, instead of offsetting plan fees charged to participant accounts.

Plan sponsors should review the terms of their plan document to determine whether the plan administrator has discretion to determine how forfeiture accounts will be used. If the plan document grants the plan administrator discretion, the plan sponsor should consider amending the plan to remove such discretion and require the plan administrator to use the forfeiture account in the desired manner. Because the plan administrator must follow the terms of the plan document, there is a strong defense against these forfeiture account claims if the plan administrator does not have discretion.

Conclusion

Understanding which plan expenses are plan payable under ERISA is crucial for plan administrators. It is important that, when expenses are plan payable, the plan administrator also has a rational basis for the allocation method it selects. Plan sponsors should carefully review how their plan document addresses plan payable expenses, allocation methods, and the use of forfeiture accounts. If there are any ambiguities or discretion, particularly concerning the use of forfeiture accounts, plan sponsors should consider amending the plan document to mitigate legal risks and protect participant interests.