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Paying Plan Expenses Out of Plan Assets

David Johanson

March 2003

Many ESOPs generally do not pay plan expenses out of plan assets. Because these expenses are typically otherwise deductible for income tax purposes and contributions to the ESOP trust are subject to the limits on annual additions under Section 415 of the Internal Revenue Code of 1986, as amended, there is usually little advantage to contributing money to the employee stock ownership trust (the "ESOT") and then using it to pay expenses. Nevertheless, some companies may prefer to pay plan expenses this way. A U.S. Department of Labor ("DOL") Advisory Opinion clarifies what expenses can be paid out of ERISA plan assets, such as ESOPs and 401(k) plans. In order for a plan to pay such expenses, the plan documentation must clearly provide for such payment.

The types of expenses that should be reviewed in this respect are included in two categories, as follows:

Direct Expenses

Independent Appraisal
Legal and Professional Fees and Expenses
Form 5500 and Audit
ESOP Travel/Conference Expenses
ESOP Third-party Record Keeping Fees and Expenses
401(k) plan Administration Costs

Indirect Expenses

Percentage of staff time spent on plan administration and operations, as detailed below under "compensation to employees."
Fiduciary Liability Insurance

Compensation to Employees and Third Parties

Payment for work that is completed by employees for 401(k) plan and ESOP record keeping services and expenses can be charged to the 401(k) trust and the ESOT if the services and expenses are clearly defined and tracked for these individuals. The 401(k) trust and the ESOT may pay a reasonable amount for the portion of time that a company employee provides services for the 401(k) trust and/or the ESOT. The costs of attending a conference that will benefit a company employee in plan administration and record keeping also should be a covered expense. Compensation to a full-time company employee who is a named fiduciary and who serves as a trustee for a plan, however, may not be paid out of plan assets.

Compensation to a fiduciary or third party (accountant, attorney, third party record keeper, etc.) who is not a company employee may be paid out of plan assets if the expenses otherwise fit the criteria summarized below.

Other Expenses

Expenses incurred as business activities or as a result of business decisions cannot be paid out of plan assets. Expenses incurred due to the implementation of the business decisions may constitute reasonable expenses that may be paid out of plan assets.

In the DOL's Pension and Welfare Benefit Administration ("PWBA") Advisory Opinion 2001-01A, the DOL clarified that the following expenses may be charged to plan assets. These items are "hypothetical situations" listed by the DOL:

Amendments and/or restatements required for GUST/EGTRRA purposes or otherwise required by the Internal Revenue Service (the "IRS");
Nondiscrimination testing necessitated by plan features or a plan amendment;
Plan operational expenses such as enrollment, administering loans, distributions, etc.;
Application for a determination letter from the IRS with respect to any plan document or amendment and all of the work that is attendant on maintaining the qualified status of a plan;
Costs of computing benefits, even if due to a corporate transaction such as in a spin-off; and
Preparation of participant disclosure statements such as summary annual reports, individual benefit statements, summary plan descriptions and summaries of material modifications.

Expenses, including professional fees, that may not be paid from plan assets are those that are incurred as settlor (plan sponsorship) functions such as items related to the "formation" of the plan (i.e., establishment, design and/or termination of the plan, particularly including the analysis of design options, even for required amendments, union negotiations and expenses relating to financial accounting).

The U.S. Treasury Regulations, Section 1.404(a)-3(d) specifically, state that "Any expenses incurred by the employer in connection with the plan, such as trustee's and actuary's fees, which are not provided for by contributions under the plan are deductible by the employer." Therefore, certain company expenses are eligible to be deducted by the company, and, unless the plan specifically states that the trust may be used to pay some plan expenses, they would be company business expenses only.

Summary of Plan Expenses Payable Out of Plan Assets

In summary, it appears that a retirement trust such as an ESOT and/or a 401(k) trust may pay (1) any reasonable expenses concerning the administration of a 401(k) plan and/or an ESOP; (2) compensation to a fiduciary that is reasonable if the fiduciary is not "named" and a full-time employee; (3) reimbursements for expenses which are properly and actually incurred in the performance of plan duties; and (4) legal, accounting and other services necessary for actual implementation or operations of the plan.

Procedural Requirements

Prior to the 401(k) trust and/or the ESOT paying any expenses, (1) the 401(k) plan and/or the ESOP must include language allowing such expenses to be paid out of plan assets; (2) the expenses must have written documentation; and (3) some expenses may need to be shared by the 401(k) trust and the ESOT and the company (but the DOL is silent in DOL Advisory Opinion 2001-01A as to the formula to be used to make a determination of the ratio of cost to each payer).

Reporting

Any payment made by a 401(k) trust and/or an ESOT to a single service provider in an amount in excess of $5,000 for any plan year must be listed on the annual Form 5500 return and will be subject to scrutiny by the IRS and the DOL.

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