The Employee Retirement Income Security Act (ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans. Two critical sections under ERISA, Sections 406(a) and 407(b), specifically address prohibited transactions to safeguard retirement assets. This blog explores these provisions, their implications, and best practices for compliance.
ERISA Section 406(a): Prohibited Transactions with Parties in Interest
ERISA Section 406(a) prohibits fiduciaries from causing the plan to engage in certain transactions with parties in interest. These transactions include:
- Sale, Exchange, or Leasing of Property: Any direct or indirect sale, exchange, or leasing of property between the plan and a party in interest is prohibited. This prevents fiduciaries from using plan assets to benefit related parties unfairly.
- Lending of Money or Other Extension of Credit: Plans are prohibited from lending money or extending credit to a party in interest. This ensures that plan assets are not put at risk by personal or corporate loans.
- Furnishing of Goods, Services, or Facilities: Fiduciaries must not cause the plan to furnish goods, services, or facilities to a party in interest. This rule prevents the misuse of plan resources for the benefit of related entities or individuals.
- Transfer of Plan Assets: Direct or indirect transfer of any plan assets to a party in interest is strictly prohibited. This maintains the integrity of the plan’s assets for the sole benefit of the participants and beneficiaries.
ERISA Section 407(b): Limitation on Acquisition of Employer Securities and Real Property
Section 407(b) of ERISA limits the amount of employer securities and real property that a plan can acquire. This section addresses the concentration risk that can arise from investing a significant portion of the plan’s assets in the employer’s own securities or real estate. Key points include:
- 10% Limitation: Plans are generally prohibited from acquiring employer securities and real property if, immediately after such acquisition, the aggregate fair market value of employer securities and employer real property held by the plan exceeds 10% of the fair market value of the assets of the plan.
- Protection Against Conflicts of Interest: This limitation aims to protect the plan participants from conflicts of interest and the financial risks associated with excessive investment in the employer’s own securities or real estate.
Implications and Compliance Strategies
Failure to comply with these prohibited transaction rules can result in significant penalties and liabilities for fiduciaries and parties in interest. Here are some strategies to ensure compliance:
- Conduct Regular Audits: Regular compliance audits can help identify and rectify potential prohibited transactions before they lead to regulatory action.
- Educate Fiduciaries and Plan Managers: Ongoing education about ERISA requirements and prohibited transactions is crucial. Ensure that all fiduciaries understand their responsibilities and the importance of compliance.
- Implement Robust Policies and Procedures: Establish clear policies and procedures for reviewing and approving transactions involving plan assets. This can help prevent inadvertent prohibited transactions.
- Seek Professional Advice: Engage with ERISA compliance professionals or legal advisors to navigate complex transactions and ensure adherence to ERISA rules.
Understanding and adhering to ERISA’s prohibited transaction rules is essential for protecting retirement plan assets and ensuring the fiduciaries meet their obligations. By being proactive and vigilant, plan sponsors and fiduciaries can avoid the pitfalls associated with prohibited transactions and safeguard the interests of plan participants.
Investment advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a Registered Investment Advisor. IFP and
Clear Financial Strategies are not affiliated.
