Professional Services Accounting ARTICLE -
Best Practices to Comply with ERISA Section 408(b)(2)
Target Audience: Legal Professionals, Professional Service Firms, Law Firm Partners, Law Firm Accounting
What is your law firm doing to make sure it is following best practices to comply with ERISA Section 408(b)(2) in case of a plan audit to reduce the likelihood of a reportable “prohibited transaction” which could trigger an Internal Revenue Service (IRS) or Department of Labor (DOL) audit, fines and penalties?
To achieve the goals of the new laws, participants and sponsors will have access to more information which will increase the responsibility of plan sponsors to act upon the information received.
Main Goal of New ERISA Law
ERISA Section 408(b) (2) became effective July 1, 2012. The main goal of the new law is to improve the transparency of fees and expenses charged to workers in 401(k) type arrangements and other “covered plans” by requiring access to greater information so participants can better manage their retirement savings. Wouldn’t it be great if law firms never had to send bills, but could get paid by clients without the clients actually knowing how much the law firm was getting paid. This is what happens when fees are “hidden” and deducted directly from participants’ investment assets to arrive at adjusted earnings or losses reported on the investments. By ensuring access to the previously undisclosed information, plan fiduciaries can assess reasonableness of compensation, identify potential conflicts of interest and satisfy reporting and disclosure requirements under ERISA.
Greater Access to Information Means Greater Responsibility to Take Action
With greater access to fee and expense information charged to participants, plan sponsors have greater responsibility. This includes the following:
- Making sure fees, expenses and compensation charged to the plan are reasonable
- Taking action swiftly if the amounts charged to a covered plan by a covered service provider are not deemed reasonable
Some Key Regulation Requirements
Fiduciaries must comply with the following requirements:
- Document all service agreements over $1,000 (i.e. all agreements must be in writing)
- Break down the total costs per service, meaning: recordkeeping costs, administration costs, investment management costs, indirect compensation costs, shareholder–type costs etc.
- Give workers core information about investments available under their plan including the costs of these investments
- Give quarterly statements for plan fees and expenses deducted from their accounts in terms of total dollars being assessed and list clearly on their participants’ statements.
- Use standard methodologies when disclosing and calculating expenses and return information to achieve uniformity across spectrums of investments that exist in plans
- Present the information in a format that makes it easier for workers to comparison shop among the plan’s investment options.
How Do You Access Reasonableness of Fees?
Now that fee and expense information will be reported to plans, how does one interpret that information and make sure the fees and expenses are reasonable? Generally when assessing any type of expense for reasonableness, a best practice is to obtain independent or 3rd party verification that the fees are comparable for a like kind of service.
What does this mean? It means that you cannot just compare fees based on a % of plan investments or a fixed dollar amount, but you must consider other factors, such as, services provided by the covered service provider and other features of the plan or plan sponsor. Other covered service providers could be providing other plans with similar or dissimilar services than that which your plan is receiving. Other plan features will include size of plan assets, number or plan participants, industry and complexity of plan sponsor and complexity of plan design.
From an auditor’s perspective, I know first hand that price for a pension plan audit for Plan A and Plan B, as defined below, will vary greatly.
Plan A Features (less complex):
(1) 125 eligible participants
(2) Only a 401(k) deferral feature
(3) No participant loans allowed
(4) Only salaried employees
(5) One location
(6) A plan sponsor that is a law firm
(7) Plan assets of $5,000,000 and
(8) All plan investments options are readily marketable mutual funds.
Plan B Features (more complex):
(1) 10,000 eligible participants
(2) Employee 401(k) deferrals and a discretionary employer contribution
(3) Three loans outstanding allowed per participant
(4) Monthly, biweekly and weekly paid employees with bonuses and overtime to be considered (5) Multiple locations
(6) A plan sponsor that is a publicly held multi-national organization
(7) Plan assets of $100,000,000 and
(8) Plan investments options have varying levels of complexity and risk.
If your firm had Plan A, you would not want to benchmark your plan against Plan B because if Plan A fees and expenses were similar to Plan B, would they really be reasonable? No. One would expect an audit of Plan B to cost significantly more than an audit of Plan A.
There exist independent benchmarking firms that have accumulated data on fees and expenses that can provide your firm with an independent study on the reasonableness of your plan fees and expenses. They will need copies of all your agreements with your service providers, copies of your plan documents, and copies of other information about your company and plan. You may also want to consider having your ERISA attorney review the benchmarking report for reasonableness and give you a legal opinion, especially if the firm is considering some type of transaction like a merger.
Even if you plan does not have more than 100 eligible participants or is not otherwise required to have a plan audit under ERISA, you should make sure your house is in order with the following best practices:
- Know your plan!! Read and understand all plan documents including prototype plans, adoption agreements and customized non-standardized plans.
- Make sure all agreements are in writing. Obtain, read and understand all service agreements.
- Review all service agreements for compliance - are you getting the services for which you are paying?
- Understand all fees being assessed and how compensation of service providers is being determined.
- Summarize all direct compensation and indirect compensation related to and paid by the plan or among service providers or other parties in interest that the plan will pay and how it will be paid, i.e., billed to plan, deducted from plan accounts. Expenses paid by plan sponsors and not by the plan fall into a separate fee category and are not considered expenses of the plan as they are not paid by the plan.
- Read carefully all contract termination fees required to be paid. These have come as a big surprise to some plans and in past and have prevented changes in service providers due to the economic burden of terminating contracts.
- Benchmark fees for reasonableness as discussed above.
- Set up processes to address unreasonable fees and expenses if they exist.
- Form a pension plan (audit) committee with meaningful continuity of those in charge of governance to be a watchdog for what is in the best interests of the plan participants.
- Ensure evidence documenting compliance with the new laws and requirements is readily available.
- Retain all communications with participants.
- Retain all information electronically in a secure readily accessible location that meets disaster recovery standards.
- Keep an electronic or three-ring binder that includes the following:
- 408(b)(2) disclosures that were provided by advisors
- 408(b)(2) disclosures that were received from other service providers
- Annual 404(a)(5) disclosure that is due out this summer
- Correspondence (including emails) exchanged between plan sponsor and parties in interest and other sources concerning fee related matters
- Correspondence (including emails) exchanged with participants on plan, fee or investment related matters
- Memorandum or communications sent to participants regarding the plan on various dates including matter or fees, investments, etc.
- Minutes from retirement plan committee meetings
- Any other information regarding the retirement plan and on going due diligence efforts, including benchmark studies
Penalties for Non-compliance
Remember non-compliance with the new rules constitutes a prohibited transaction. Prohibited transactions get reported to the IRS and DOL and are disclosed on Annual Form 5500, audited plan financial statements and elsewhere. Excess compensation must be returned to the plan. The existence of prohibited transactions could trigger an IRS or DOL audit and subject the plan sponsor to penalties.
The most important reason to follow the new law and put in place best practices. is not for fear of penalties or an IRS audit, but rather to protect your participants’ hard earned retirement savings. “Unhiding” fees and expenses and holding service providers accountable for reasonableness puts more money back into retirement savings. With greater information comes greater responsibility and hopefully, greater retirement savings for you and your plan participants.
K. Jennie Kinnevy is the director of the Law Firm Services Group at Feeley & Driscoll, P.C. (www.fdcpa.com). The Law Firm Service Group provides tax, accounting, business advisory and consulting services to help law firms grow profitably. Based in Boston, Massachusetts, Jennie can be reached by phone at 888-875-9770.
Find out how our expertise in professional services accounting can add value to your business. Email us or call us at 1 (888) 875-9770.
Originally published in Accounting and Financial Planning for Law Firms
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