Be Careful Not to “Float” into an ERISA Violation

November 30, 2012 (PLANSPONSOR.com) – Sponsors of ERISA-governed retirement plans need to review the definition of “float.”
By PS

“Float” is: 

  1. An ice cube bobbing in water or soda   
  2. Root beer (or another favorite soda) poured over ice cream   
  3. Service provider compensation from overnight investment of certain amounts held under a defined contribution plan 
  4. All of the above 

 

The answer is (d).  However, which one of these three can raise important Employee Retirement Income Security Act (ERISA) plan issues?  The answer to that question, of course, is (c).  It is a topic that the Department of Labor (DOL) has addressed multiple times in recent years.  And it can be relevant to ERISA 403(b) plans as well as other ERISA defined contribution plans.    

Not all plan investment arrangements involve float income; some invest in non-interest bearing accounts to avoid potential plan issues.  For those arrangements that do include float income, it is an important issue, as evidenced by DOL guidance on the subject as well as some recent court decisions, and one large court award in particular.

A common form of float income can involve a service provider holding amounts such as defined contribution plan contributions that have not yet been allocated to a participant and plan distributions pending presentment of a distribution check in an interest-bearing account, with the service provider retaining the associated interest. The rate of interest (or other return) might vary from time to time, and the amount of income to the service provider can also vary based on how long the amount remains there pending allocation or presentment, which may in turn depend on actions by the plan sponsor, the participant, or another party. As the DOL has clearly indicated, these amounts are considered compensation and thus must be considered for multiple plan purposes, including general operation, fee disclosure, and completion of Form 5500.  It is the Form 5500, and more recently the required fee disclosures, that have focused more attention on the subject.  

A plan’s service arrangements with third parties are governed by some important ERISA restrictions, including the requirements that:  

  • the compensation be reasonable for the services provided, and  
  • the arrangement not otherwise give rise to a prohibited transaction, such as through self-dealing via discretionary control. 

 

These determinations are the province, and responsibility, of a designated plan fiduciary.  In order for that individual (or committee) to make an informed decision about the reasonableness of proposed services and associated compensation, the service provider must disclose sufficient information to allow the plan fiduciary to evaluate them, either separately (in an unbundled arrangement) or in the aggregate (in a bundled arrangement). Compensation derived from float income, if there is any, must be considered in this evaluation. However, because of the number of unknowns, this form of compensation generally must be estimated.  Moreover, the circumstances giving rise to the opportunity to earn additional interest (such as the number of days a contribution that cannot be allocated to a participant account or a plan forfeiture account will be held before it is returned to the plan sponsor), to the extent they are subject to the control of the service provider, should be subject to specific limitations.  Of course some things cannot be controlled, such as the length of time it takes a participant to cash a distribution check.

Example 1: Employer engages Service Provider for plan administrative services on Service Provider’s platform.  Employer determines a range for a reasonable fee for these services, and Service Provider proposes to charge the highest amount in that range.  However, Service Provider has not taken into account likely float income, so when the administrative service fee is added to the float income that the Service Provider estimates it will receive, the total expected compensation exceeds the range for reasonable compensation that Employer has determined.  As a result, the arrangement is considered a prohibited transaction.  

Example 2: Same facts as Example 1, except that Employer and Service Provider agree to a lower total compensation amount, including the estimated float income, and this total is now within the range of reasonable compensation that Employer has identified for the services being provided.  The float compensation no longer causes the arrangement to be a prohibited transaction, provided that the factors affecting the magnitude of the float income that are within the Service Provider’s control are subject to specific limitations.  

In Example 2, both Employer and Service Provider can relax, and perhaps enjoy the other types of “float” to celebrate a job well done. 

 

Richard Turner, vice president and deputy general counsel, VALIC      

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. 

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