When we first established our 401(k) plan, the company didn’t have a lot of discretionary income, so we went with a low-cost provider and set it up so the plan would pay for its own fees. We have since been told that paying fees out of the plan isn’t that straightforward.
Are we allowed to pay 401(k) plan-related expenses out of the plan assets?
This is another one of those questions with a short answer and a longer answer. The short answer is yes, it is perfectly allowable for some 401(k) plan expenses to be paid out of plan assets, but the flip side of that is that there are some expenses that are not allowed to be paid from the plan.
As a general rule of thumb, if a particular service is required in order to maintain the plan’s compliance, the fees for that service can be paid from the plan. The easiest examples of required services are performance of the annual nondiscrimination testing and preparation of the Form 5500 each year. Another example is a plan amendment or restatement that is required because of a law change.
You are probably wondering what are some expenses the plan is not allowed to pay. Using our same rule of thumb, but in reverse, fees for optional services generally cannot be paid out of plan assets. An example might be the fee your TPA charges you to run a series of projections to help the company decide whether or not to implement a safe harbor or cross-tested provision. Those projections are optional and are for the benefit of the company, not the participants. As a result, the fees cannot be charged back to the plan.
Unfortunately, there are some fees that aren’t quite so easy to classify. Take fees for plan corrections as an example. Let’s assume that the plan’s ADP test is run incorrectly (or not at all) for a number of years. Once the error is discovered, it is necessary for the plan’s compliance to re-run those tests the right way and take any corrective action that might be identified. Regardless of who was at fault for the incorrect test results, the law ultimately holds the plan sponsor responsible for the proper maintenance of the plan. As such, the plan sponsor cannot shift the financial burden for the corrections to the plan.
There are several additional factors that are really important. One is that the answer doesn’t change just because you are thinking of using forfeitures or an ERISA spending account to pay the fees. Both of those types of accounts are still plan assets. The fact that those amounts are not allocated to specific participants has no bearing on whether the plan can pay a given expense.
Also, just because you can doesn’t mean you should. Other than transaction-type fees, e.g., for a participant loan, which are usually charged just to the participant who initiated the transaction, fees for more general plan services (like testing and Form 5500 prep) are usually spread pro rata across all participant accounts. If the business owner(s) hold a sizeable portion of the total plan assets, they will have a proportionate portion of the overall fee deducted from their accounts. Since both plan contributions and payment of plan expenses are tax-deductible, it often makes more financial sense to have the company pay the fee and take the additional tax deduction than to have the owners use their already-tax-deferred plan account to pay the majority of the fees.
The good news is that it doesn’t have to be all or nothing. It is perfectly acceptable to charge transaction-based fees to the accounts of the participants who initiate them while having the company pay for the more general plan fees. It is critical, however, to ensure that similarly situated participants are treated the same. It would be discriminatory and, therefore, not allowed to make lower paid participants pay for their own transaction fees while not requiring the same of the owner(s).
If you’re confused about whether or not you can charge a fee to your plan, give us a call. While we cannot make the final determination for you, we are glad to talk through the particulars with you to help you arrive at an appropriate decision.
For more information about using plan forfeitures to pay plan expenses, please visit our Knowledge Center here.