Multiple Employer Plans: The Devil is in the Details Roger J. Rovell, Esq. Ward Rovell (813) Tampa, Florida

TOPICS I.Payment of Plan Expenses II.Overlooked Testing Issue: “Mandatory HCE Aggregation” III.Departed or Problem COs: Getting Rid of Plan Assets IV.Multiple Employer Plan Arrangements for HRO/ASO

I. Payment Of Plan Expenses ERISA §404: Plan assets should be used for exclusive purpose of providing benefits and Defraying reasonable administrative expenses. Decision to pay expense from plan assets is a fiduciary function.

According to Department of Labor (“DOL”) – Two basic categories of employee benefit plan expenses. Settlor expenses – relating to the formation, design or termination of plan. Plan management or non-settlor expenses – includes plan management, implementation or maintenance expenses.

Settlor expenses cannot be paid by plan. According to Department of Labor – Formation, design and termination (i.e., settlor) expenses are incurred for benefit of employer; expenses employer expected to bear in the normal course of business.

Non-settlor administrative expenses. Once established, plan must be implemented, managed and administered (i.e.,non-settlor expenses). If implementation, plan management or administrative expenses are reasonable they may be paid from plan assets. Fiduciary to determine if expense reasonable. DOL does not issue advisory opinions on whether expense is reasonable.

Cost to establish plan. Feasibility study and design expenses are settlor functions – not payable from plan assets. Preparation of initial plan document is settlor function – not payable from plan assets. Expenses to implement settlor decision may be expenses payable from plan assets. Plan communication (SPDs, etc.). Amendments required by changes law. Requesting IRS determination letter.

Administrative expenses. Reasonable plan administrative expenses may be paid by the plan – Third party service fees for record keeping and administration (including start-up costs). Legal fees for plan related issues. Cost of reporting and disclosure (SPDs, annual reports, summary annual reports). Cost of bond.

Bundled administrative services: apportion between settlor and non-settlor functions.

Amendments to Plan. Plan amendment may be settlor function (not payable from plan assets) or expense payable from plan assets. Amendment to maintain tax qualified status of plan – payable from plan assets. Amendment to modify plan design is settlor functions – not payable from plan assets. Amendment often have dual characteristics.

IRS determination letter. No requirement to obtain determination letter; strongly advised by practitioners. Cost of obtaining IRS determination letter is payable from plan assets.

Plan termination expenses. Dual characteristics – settlor and non-settlor (implementation) expenses. Expense associated with decision to terminate deemed settlor expense not payable from plan assets. Amendment terminating the plan is settlor function not payable from plan assets. Portion of amendment expense may be payable from plan assets: cost to update plan to comply with current law as of termination date.

Cost to obtain IRS determination letter upon termination: implementation cost payable from plan assets. Costs of processing distribution elections, preparing checks: implementation cost payable from plan assets. Final 5500 for terminated plan is administrative expense payable from plan assets.

Plan communication expense. ERISA disclosure requirements: Generally viewed as plan management or non-settlor functions payable from plan assets. Includes cost of preparing SPDs and summary annual reports.

Administrative services provided by plan sponsor/fiduciary. Plan sponsor/fiduciary can provide administrative services to plan if fiduciary receives no compensation. Exception: Fiduciary can receive reimbursement of direct expenses properly and actually incurred in the performance of administrative services.

Under DOL regulations, expense is not direct expense to the extent it would have been sustained had the service not been provided or if it represents an allocable portion of overhead costs.

Direct expenses include in-house costs to administer benefit programs, such as – Salary and benefits costs of benefit department personnel. Long distance telephone expenses. Dedicated computers. Copying. Mailing costs. Plan-related business travel and education expenses. Plan sponsor may not charge plan for overhead costs, including rent, office space and general telephone expense.

Reimbursement of plan sponsor for employee salary and fringe benefits: Be able to demonstrate that, except for the services provided to the plans, the employees would not be employed. Salaried employee should spend large majority of time on plan administration (must apportion if necessary). Detailed record keeping to substantiate time spent by employees (on an hourly basis) on plan administration.

Hourly employee that does not provide full-time services to plan: May be reasonable to assert expense would not have been sustained had the service not been provided. Careful documentation of hours spent on plan administration.

Recent DOL and IRS guidance on allocating plan expenses. DOL Field Assistance Bulletin (FAB ) and IRS Revenue Ruling (Rev. Rul ). Plan language controls – If plan has specific provisions for allocating expenses, fiduciaries must follow.

If plan documents are silent, fiduciaries must act prudently and in the interest of participants. According to DOL, ERISA places few constraints on how expenses are allocated; plan sponsor has considerable discretion.

Expenses Allocated to Individual Accounts. Some expenses may be charged solely to individual’s account, including: Hardship distribution expense. Benefit distribution expense. QDRO determination expense. Fees for self-directed investment options. Plan loan expenses.

SPD must disclose expenses that may be paid from plan assets. Reasonable administration expenses can be charged solely to terminated vested participants – even if expenses not charged to active participants.

Allocating expenses among all participants – pro rata vs. per capita. Guidance addresses whether general plan expenses should be allocated on a pro rata or per capita basis. Pro rata method allocates expenses among individual accounts on the basis of assets in an individual account. Per capita method allocates expenses equally to each account.

Method of allocation must be reasonable. Selected method might favor one class of participants if rational basis for the selected method.

DOL: pro rata method in most cases an equitable method of allocation. DOL: per capita method may be used for allocating certain fixed administrative expenses, such as: Record keeping. Legal. Auditing. Annual reporting. Claims processing and similar administrative expenses.

Fees determined on the basis of account balances, such as investment management fees, should be charged pro rata. Investment advisory services to individual participants might be charged either pro rata or per capita without regard to actual utilization. Investment advisory services might also be charged on a utilization basis to individual’s account.

Recap of Expenses that Should Not be Charged to Plan (i.e., settlor expenses): Plan establishment, design and termination costs (implementation of these settlor costs may be payable by plan). Plan amendments with a business purpose and without a compliance/regulatory component. Cost associated with correction of plan defects under voluntary correction programs. Excise taxes and cost of preparing forms to pay excise taxes.

Recap of Expenses that May be Charged to Plan: Third party administration fees. Legal fees relating to plan issues. Investment advisory and management fees. Third party trustee or custodian fees. Bonding cost. Accounting fees.

Claims processing and payments – check writing, benefit calculations, hardship distributions, distribution processing. Reporting and disclosure costs (i.e., SPDs, annual reports and summary annual reports). Plan amendments for regulatory compliance or to preserve tax-qualified status. Implementation costs of plan establishment, amendment or termination.

Determination letter costs. Direct expenses of plan sponsor.

II.Overlooked Testing Issue: “Mandatory HCE Aggregation” Rule applied when HCE participates in more than one 401(k) plan maintained by the same employer during plan year. Rule applies to HCEs only. HCE’s deferral amounts and matching contributions in all 401(k) plans in which HCE participates must be added together when computing HCE’s deferral percentage and matching percentage under each 401(k) plan. Regulations suggest that compensation also aggregated.

Failure to apply rule results in failure to correctly perform nondiscrimination tests: Could result in plan disqualification.

Common scenarios requiring HCE aggregation : Example 1: Client organization (“CO”) maintains 401(k) plan for part of plan year and transitions to a PEO multiple employer plan (“MEP”) during same plan year. For discrimination testing purposes, CO is deemed to maintain two 401(k) plans during the plan year: CO-sponsored plan and PEO- MEP. Mandatory HCE aggregation applies to each plan.

Example 2: CO adopts MEP sponsored by PEO-A. CO Terminates relationship with PEO-A during plan year and enters into relationship with PEO-B and adopts PEO-B’s MEP. CO’s HCEs participate in two 401(k) plans (PEO-A’s MEP and PEO-B’s MEP). Each MEP must apply mandatory HCE aggregation.

Possible options for dealing with mandatory HCE aggregation rule. Each plan separately runs nondiscrimination tests. Practical problems: Requires HCE deferral (and matching and compensation) data to be shared between plans – data would not be available for several months after transition event occurs. If corrective distributions are necessary, assets may not be available for distribution.

Consider “permissive aggregation” – All 401(k) plans in which HCE participates during a plan year are tested as one single plan for the entire plan year. Mandatory HCE aggregation is satisfied since both HCE and non-HCE deferrals (and matching and compensation) under all plans are aggregated. Requires less testing –one set of nondiscrimination tests.

For permissive aggregation, plans must have same plan year and use same testing method. Current year testing method is generally easier to apply. For mid-year transitions, parties may agree that plan covering employees at end of plan year will perform nondiscrimination tests. See PEO Insider article “Testing Trap for the Unwary: An Overlooked Issue for Multiple Employer Plans”, May 2004.

III. Departed or Problem COs: Getting Rid of Plan Assets Departed COs often leave assets in PEO - MEP. Administrative hassle and expense associated with assets. Failure of CO to follow tax qualification rules can risk qualified status of entire PEO-MEP. Failures can range from coverage testing to failure to make top-heavy contributions. Might protect PEO-MEP if “offending” assets are removed from PEO-MEP. See PEO Insider article “Avoiding Retirement Plan Disqualification,” November 2000.

Participant distributions may not be permissible method of removing assets from PEO-MEP. Asset transfer may be acceptable, but – No trustee-to-trustee transfer unless CO agrees to establish successor 401(k) plan to receive asset transfer. See PEO Insider article “Saying Goodbye to Employees and Clients,” February 2003.

To encourage CO to establish successor plan - Client service contract could require payment of fees if departed client refuses to establish successor plan. Plan provisions could trigger full vesting if assets are not transferred within specified time.

Establishing a “spin-off/termination plan”. Spin-off/termination plan receives asset transfer from the PEO-MEP, then immediately terminated and assets distributed to participants. Trustee-to-trustee transfer from PEO-MEP to spin-off/termination plan is not an impermissible distribution from PEO-MEP.

CO may refuse to adopt/execute a spin off/termination plan. Solution: Have CO agree in advance to appoint PEO as agent for purposes of establishing spin-off/termination plan. Careful drafting is important to allocate as much liability as possible to CO for the spin- off/termination plan.

IV. Multiple Employer Plan Arrangements for HRO/ASO. 401(k) options: ASO client could adopt a PEO-MEP The ASO client could have stand-alone plan sponsored by ASO client. Advantages of using MEP: Bonds ASO client; value-added proposition. Administrative cost for MEP is generally lower than the cost for stand-alone single employer plan.

Plan drafting issues. A PEO-MEP may be drafted to exclude individuals who are not on PEO payroll. PEO-MEP can be modified to override this feature for ASO adopters.

Section 125 plans. PEOs generally maintain either single employer Section 125 plans or “multiple employer style” Section 125 plans (“ME style 125 plan”). ME-style 125 plan could be used with ASO client. ASO client could sponsor stand-alone 125 plan. PEO single employer 125 plan should not cover employees of ASO client. No employment relationship between the PEO/plan sponsor and employees of ASO client.

125 plan sponsored by ASO client may be “cleaner” option. Unresolved issues/gray areas, especially if ME-style 125 arrangement includes medical flexible spending account plan.