Payments to fiduciaries and other parties in interest for providing administrative and investment services to ERISA-covered retirement plans are prohibited transactions under both ERISA and the Internal Revenue Code. However, both the labor law and the tax code provide a statutory exemption for payment of "reasonable fees" for necessary plan services. Neither the U.S. Department of the Treasury nor the Department of Labor (DOL) has defined how a plan fiduciary can demonstrate that a plan expense is reasonable and so exempt from the prohibited transaction rules.
Under interim final regulations scheduled to become effective July 16, 2011, the DOL has announced an obligation by retirement plan service providers to disclose information to fiduciaries to enable them to make determinations regarding the appropriateness and reasonableness of investment and administrative fees. Guidance on disclosures for health and welfare plans will be issued later. The new rules will apply to new and existing retirement plan service contracts.
Plan service providers must make fee disclosures for direct or indirect payments from plan assets that will total $1,000 or more in a plan year, including:
- Fiduciary and registered investment advisor fees.
- Fees for recordkeeping or brokerage services for participant-directed individual account plans.
- Services, including accounting, auditing, actuarial, appraisal, banking, consulting, custodial, insurance, participant investment advice, legal, brokerage, third-party administration, and valuation.
Required written disclosures will include:
- A description of services to be provided.
- A description of the direct or indirect fees from the plan that the service provider expects to receive in exchange for the services (if indirect, the source and payor of the indirect compensation).
- Any fees payable on termination of the contract (surrender fees, contract termination fees, etc.).
- The allocation of compensation among affiliated service providers or to a subcontractor, if fees are transaction-based or asset-based and netted against the investment return of the investment option. Under this category, the disclosure must identify the services, the payor and the recipient of the compensation.
- A description of how/when the compensation would be received (deducted quarterly, monthly, etc., from the assets in the plan or paid as a disbursement from the plan).
- For third-party recordkeeping services, a disclosure of all direct and indirect compensation. If a bundled contract does not identify a specific periodic amount for recordkeeping (e.g., where the "recordkeeping is free"), the recordkeeper must disclose a reasonable good faith estimate of the cost to the specific plan for providing the recordkeeping services, explaining the methodology and assumptions used to prepare the estimate. The regulation states that such estimates could take into account standard rates that the recordkeeper charges to unrelated third parties on an unbundled basis or the prevailing market rates charged for similar services to similar (by asset or participant size) plans.
It has been extremely challenging for plan fiduciaries to compare competing proposals from bundled investment, custody and recordkeeping service providers. Upon implementation of these regulations, service arrangements between affiliates and non-affiliated subcontractors and alliance partners and fees paid will now be more transparent to plan fiduciaries. Once fiduciaries have full knowledge of who is getting paid and for what, they will be better able to satisfy their fiduciary obligation of determining whether all parties being compensated from the plan are doing so under arrangements that are "reasonable."
Failure to obtain or to provide the required disclosure will make any compensation paid to a service provider who is a "party in interest" to an ERISA-covered retirement plan a prohibited transaction under ERISA and the tax code. Such a transaction is subject to excise tax penalties and annual filings until corrected. If a plan sponsor has relied in good faith on information provided by the service providers, there are regulatory exemptions for the plan from the prohibited transactions rules and excise tax; such tax will still be owed by the service provider in some cases.
The DOL is open to and accepting comments on the regulations and may make additional changes prior to the effective date of July 16, 2011.