ERISA Section 404(a)(i)(A) states that plan assets must be used for the exclusive purpose of providing benefits to participants and defraying reasonable expenses associated with administering the plan. Recently, four large employers were sued for breach of fiduciary duty related to their purported misuse of plan assets. Specifically, one plaintiff’s law firm sued Clorox, Thermo Fisher Scientific, Qualcomm, and Intuit accusing each of breaching ERISA’s duty of loyalty by using plan forfeitures to reduce employer contributions instead of using them to offset administrative costs applied to participant accounts.
These lawsuits pit a long-held IRS rule which expressly allows plan sponsors to use forfeitures either to offset plan expenses or reduce employer contributions, against ERISA’s exclusive purpose rule expressed in Section 404(a). It seems self-evident that placing forfeited dollars back into participant accounts in the form of a matching or profit sharing contribution is exclusively benefiting participants, but apparently that’s not how some creative plaintiff’s attorneys see it. With that said, we believe it’s important to review the nature of plan-related administrative expenses and how these expenses are paid, either by the company or by the plan.
Settlor Expenses vs. Non-Settlor Expenses
There are two types of plan-related administrative expenses under ERISA: settlor and non-settlor expenses. Settlor expenses are associated with plan activities that exclusively benefit the plan sponsor. Examples of settlor expenses include costs to create or terminate a plan, or costs associated with studies conducted to determine the cost to the company of changing plan design. Under Section 404(a), because they exclusively benefit the employer, settlor expenses must be paid by the company.
Non-settlor expenses are associated with the implementation and ongoing administration of the plan to ensure the plan maintains its tax qualified status. Examples of non-settlor plan expenses include recordkeeping, required plan amendments, annual required discrimination testing, required participant notices, and costs associated with educating plan participants on the retirement plan benefit. Plan fiduciaries may elect to have non-settlor expenses paid either by the company or by the plan.
It is equally important to monitor and ensure that services being paid for by the plan are being exclusively used by plan participants. Depending on the organization, it is important to verify that groups of employees who are not plan participants – foreign workers or union workers as examples – are not using the benefits being paid for by the plan.
Use of Forfeitures
Participant forfeitures, which result when a non-vested account balance is surrendered by a participant at termination, must remain in the plan. Plan fiduciaries are permitted to utilize forfeitures to either offset future employer contributions or defray plan administrative expenses, but these options must be expressly codified in plan documents. If the plan sponsor desires to use forfeitures to offset administrative expenses or offset company contributions, it must do so within twelve months of the end of the plan year in which participant assets are forfeited. If this deadline is not met, or the plan document does not specify how forfeitures are to be used, the IRS requires forfeitures be re-allocated to participant accounts.
The bottom line is while ERISA allows plan fiduciaries to utilize forfeitures to offset non-settlor administrative expenses, it is important for plan fiduciaries to understand their prescribed use according to plan documents.
Steps to Ensure Appropriate Use of Plan Assets to Pay Plan Expenses
- Review plan documents to determin available uses for plan forfeitures;
- Determine if the plan document requires specific sequencing in the use of forfeitures;
- Amend the plan document to allow greater flexibility if needed to meet the preferred use of forfeitures;
- Ensure internal processes allow for the timely use of plan forfeitures according to IRS regulations; and
- Monitor use of benefits such as investment advisory services to ensure their use is limited plan participants.
