Payment of Plan Expenses (Posted June 30, 2001) Technical Tip 15: The following question and answer are from the DOL Q&A Session at the 2000 ASPPA Annual Conference: Is there a requirement that the employer pay any of the administrative and/or investment expenses of a 401(k) plan or may they all be paid from plan assets? What types of expenses cannot be paid by the plan? DOL Response: The PWBA has a 401(k) fee initiative which is intended to educate both participants and plan sponsors about the impact of fees on participants’ return on investments. The PWBA has developed a consumer information brochure on plan investment fees designed to educate participants on understanding investment fees and to remind plan sponsors of their fiduciary obligations to monitor these fees, especially where the fees are paid by the plan itself rather than by the plan sponsor. [See the two brochures-- "A Look At 401(k) Plan Fees . . . For Employees" and "A Look at 401(k) Plan Fees . . . For Employers" available on our website.] It depends on who the plan document states is responsible for the payment of administrative and investment expenses of the plan. The decision as to which expenses will be paid by the plan sponsor, which will be paid by the plan, and/or which will be shared, is a decision of the plan sponsor. That decision is then expressed by the terms of the plan document. However, the plan cannot pay expenses which are for the benefit of the plan sponsor, i.e., "settlor" expenses. The plan sponsor or the person selected must carry out the following fiduciary responsibilities with respect to 401(k) plans: (1) selection of the investment options from which participants choose, (2) selection of service providers, (3) monitor the performance of the investments and the provision of services. As such, employers are required to consider the costs to the plan and ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided. See the Israel letter, Advisory Opinion 97-03A. That letter states in part: "Concerning sections 403 and 404 of ERISA, as a general rule, reasonable expenses of administering a plan include direct expenses properly and actually incurred in the performance of a fiduciary’s duties to the plan. On the other hand, the Department has long taken the position that there is a class of discretionary activities which relate to the formation, rather than the management, of plans. These so-called "settlor" functions include decisions relating to the establishment, design and termination of plans and, except in the context of multiemployer plans, generally are not fiduciary activities subject to Title I of ERISA. See letter to John N. Erlenborn from Dennis M. Kass (March 13, 1986). Expenses incurred in connection with the performance of settlor functions would not be reasonable plan expenses as they would be incurred for the benefit of the employer and would involve services for which an employer could reasonably be expected to bear the cost in the normal course of its business or operations. See letter to Kirk F. Maldonado from Elliot I. Daniel (March 2, 1987). . . . With regard to expenses attendant to amending a plan to maintain its tax-qualified status and to obtaining a determination from the Internal Revenue Service concerning the status of the plan in connection with termination, we note that, while ensuring the tax-qualified status of a plan confers significant benefits on the plan sponsor, or in the case of a liquidation, the estate of the plan sponsor, maintenance of tax-qualified status may also be in the interest of plan participants. In the case of a plan that was intended to be maintained as a tax-qualified plan and that permits the payment of reasonable expenses from the assets of the plan, it is the view of the Department that a portion of the expenses attendant to these activities may constitute reasonable expenses of the plan. Where, as here, there are benefits to be derived by both the plan sponsor (or the estate of the plan sponsor) and the plan, and where one party appears to be acting in both a settlor capacity on behalf of the plan sponsor (or the estate of the plan sponsor), and in a fiduciary capacity on behalf of the plan’s participants and beneficiaries, it would generally be necessary, in order to avoid violations of ERISA sections 406(b)(1) and 406(b)(2), to have an independent fiduciary determine how to allocate the expenses attributable to those benefits." In its publication "A Look at 401(k) Plan Fees . . . for Employees," the PWBA, speaking to employees, explained its concern with the payment of inappropriate or excessive fees from plan assets: In addition, the PWBA points out the responsibilities of employers/fiduciaries to prudently manage the fees. "1. Why consider fees? In a 401(k) plan, your account balance will determine the amount of retirement income you will receive from the plan. While contributions to your account and the earnings on your investments will increase your retirement income, fees and expenses paid by your plan may substantially reduce the growth in your account. The following example demonstrates how fees and expenses can impact your account. Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent. . . . . . You should be aware that your employer also has a specific obligation to consider the fees and expenses paid by your plan. ERISA requires employers to follow certain rules in managing 401(k) plans. Employers are held to a high standard of care and diligence and must discharge their duties solely in the interest of the plan participants and their beneficiaries. Among other things, this means that employers must: Establish a prudent process for selecting investment alternatives and service providers; Ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided; Select investment alternatives that are prudent and adequately diversified; and Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices." MODERATORS COMMENT: There are several steps in analyzing whether an expense may be paid from plan assets: (1) Does the plan or trust document permit the payment of that type of expense? (2) Is the payment legally permissible under Title I of ERISA? (3) Is the amount reasonable? (4) (5) Should a portion of the expense be allocated to the employer? Should the payment be allocated to the trust as a whole, to specific participants, to a forfeiture account, or otherwise? (6) What do the plan documents say about the allocation? And so on. Comment by the RLR&C ERISA Attorneys: This response was given prior to the PWBA's issuance of the "Stoney" Advisory Opinion (No. 2001-01A) and six related hypothetical fact situations which discuss in detail the expenses which can be paid from plan assets vs those which must be paid from plan assets. (To obtain a copy of the Advisory Opinion and six related hypothetical questions and answers published by the DOL at the same time, click here.) Briefly, the DOL indicates that the cost of complying with qualification requirements, including discrimination testing, the preparation of amendments to the plan needed to comply with changes in law and applying for a favorable determination letter may be paid out of plan assets. On the other hand, the cost of preparing amendments to implement changes in plan design and the cost of applying for a favorable determination letter on these types of amendments are "settlor" expenses which must be borne by the employer. Other types of expenses, as well as the PWBA's approach to the payment of expenses, are discussed in the Advisory Opinion and related hypotheticals. Caveat: The answer was drafted by Fred Reish and Brad Huss, the program moderators, based on their understandings of discussions with four senior officials of the Pension and Welfare Benefits Administration (PWBA) of the U.S. DOL. As a result, it does not represent a formal or binding position statement by the PWBA. View all Tips © 2012 Reish Luftman Reicher & Cohen, a Professional Corporation Important notice: Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner's situation. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of your situation.