Fees, expenses and revenue sharing are the topics du jour for 401(k) plans—and particularly for mid-sized and large plans. As a result of the focus on those topics, we are seeing more and more in the way of either “revenue sharing” deposits or credits by recordkeepers for 401(k) plans. The purpose of those deposits or credits is to give plan sponsors the benefit of “excess” compensation that was paid to 401(k) recordkeepers.

As the wording—“deposits” or “credits”—suggests, the recapture of revenue sharing (in excess of the charges of the recordkeeper) comes in two forms. The first is that the excess amounts may be deposited into a plan as an unallocated account. During the course of the plan year, those monies can be used to pay expenses that are prudent and appropriate for the plan to pay out of plan assets. Any amounts remaining at the end of the year must be allocated to the participants. The most common way of doing that is to allocate the amounts pro rata to the account balances on the last day of the year (for example, the account balances on December 31 for a calendar-year plan).

The other way that excess revenue sharing is being used is through a “credit.” In that scenario, the recordkeeper creates a bookkeeping account on its records and allows the plan sponsor to use that money for plan expenses—often without any time limit for doing that. As that suggests, the credit amounts are typically not allocated to participants at the end of the year. In some cases, the credit amounts are ultimately forfeited back to the recordkeeper (for example, if they are not used by the time the plan transfers to another recordkeeper) or they are ultimately deposited into the plan (for example, if the plan sponsor demands the deposit of those amounts).

Of course, in neither case may the deposits or credits be used for the benefit of the plan sponsor.

Where the amounts are deposited into a plan, they are obviously plan assets. But, are the amounts also plan assets when they are recorded as credits on the books of the recordkeeper? The answer may be that they are not when the recordkeeper can keep the credits. However, when the plan can demand the payment of the credit to or for the benefit of the plan and its participants, without limit or restriction, they probably are, because ERISA determines whether something is a plan asset by applying ordinary notions of property rights. For arrangements that lie between those two, the answer is unclear—and a close legal analysis is required.

The conclusion is significant—for example, the determination will impact whether the account must be included in the accountant’s audit of the plan, must be allocated to participants each year, and so on. Needless to say ... consult your ERISA attorney on this one—and get the answer in writing.

POSTSCRIPT: The government regulators are becoming aware of the existence of these amounts. For example, the newly issued 5500 package for 2009 specifically references their existence in the Schedule C discussions.

 

Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.

Source: The Adviser Report