Retirement Plan Rules

Retiring early?
This is one situation where it could be a bad idea to roll over the 401(k) into an IRA. If you are at least 55 in the year you leave your job, you may be able to withdraw money from your 401(k) at any time without penalty. But if you roll the money over into an IRA, you're generally hit with a 10% early withdrawal penalty if you touch the cash before age 59½.

Public employees can make a similar mistake: If you have a 457 plan, you can withdraw the money without penalty after you leave your job -- no matter how old you are. But if you roll it over into an IRA, you'll generally have a 10% penalty for withdrawals before age 59½, too.

There are a few ways to access the IRA money before that age as an example, if you were to withdraw substantially equal amounts each year based on your life expectancy (called the 72(t) rule). To avoid the penalty, you must make these withdrawals for at least five years or until age 59½, whichever is longer.

But it would be a lot easier just to leave your money in the employer's plan for the moment, so you can withdraw it without penalty if you need it before age 59½. Or you can shift some of the money into an IRA and leave some in the 401(k), keeping some of it available. Regardless of whether you make the rollover, you still will owe income taxes when you withdraw the money from a 401(k), 457 or traditional IRA.

Will my IRA be disqualified if it invests in my
FLP to receive valuation discounts?
August 6, 2001

Maybe. Under a 2000 advisory opinion by the Department of Labor, estate planning clients may now be able to combine IRAs and family limited partnerships (FLPs) to receive valuation discounts for the IRA assets. By investing the IRA in a FLP, the client could greatly reduce the taxable value of the IRA assets, just as with other FLP property. This technique may lead to reductions in income taxes on IRA distributions, as well as reductions in estate taxes.

Estate planners have considered this untested technique for years, but have discouraged clients from trying it because of the risk involved. If the IRA's investment in the FLP were found to be illegal, the IRA would be disqualified and the assets would be taxed as if the IRA had made a lump-sum distribution.

But this ruling (2000-10A) may embolden more planners and investers to use FLPs to receive valuation discounts for IRA assets.

The ruling involved a FLP that owned only marketable securities. The family members had formed the partnership to pool their investment assets to meet the minimum amount required by a particular investment manager. One of the family members owned a $500,000 IRA, which the investment manager would only manage if the funds were owned by the FLP.

The IRA owner proposed having his IRA contribute its funds to the FLP in exchange for partnership interests. But the IRA owner and his family members were all "disqualified persons" under §4975(c)(1)(A), meaning that a transaction between them and the IRA would violate that section of the Code. Would a transaction between the IRA and the partnership to which these disqualified persons belonged also violate the Code?

The Department of Labor ruled that even though the IRA owner and his family members were disqualified persons, the transaction would be solely between the IRA administrator and the partnership and would therefore not be prohibited. However, the Department of Labor did not rule on whether or not the transaction would violate other provisions, including one that prohibits transactions in which the IRA assets are used by or for the benefit of a disqualified person, and another which prohibits transactions in which the IRA owner deals with the IRA assets in his own interest.

So, it is still unclear whether or not this technique is safe in many circumstances. Always consult a qualified estate planning attorney to see what techniques are best for your estate.

Source: Lawyers Weekly USA
US DOL Advisory Opinion 2000-10A, 7-27-2000

By Denise Appleby, CISP, CRC, CRPS, CRSP, APA
July 30, 2003

Between the time you contribute to and distribute from your IRA, you will likely invest your assets to make the best possible return. When investing your IRA assets or implementing certain transactions, you must exercise caution. Lack of knowledge about the rules can lead to serious tax consequences, including the disqualification of your IRA assets. To assist IRA holders in protecting the qualified status of their IRAs, the department of labor provides a list of transactions that IRA holders should avoid, which are referred to as "prohibited transactions". Here we review the common prohibited transactions for IRAs, SEP and SIMPLE IRAs.

A broad definition of a prohibited transaction is the improper use of your IRA assets by you - the IRA owner - your beneficiary, or certain other parties who are referred to as "disqualified persons". Disqualified persons include:

The following are examples of improper uses of IRA assets that result in prohibited transactions:

Generally, the IRA assets involved in a prohibited transaction are treated as though they were distributed on the first day of the year in which the transaction occurred. This means that the assets must be added into the income of the IRA owner, and if the IRA owner is under age 59.5, the early-distribution rules will apply. For prohibited transactions involving pledging the IRA balance as security on a loan, only the amount pledged is considered disqualified and treated as a distribution.

The type of IRA product you purchase usually determines your IRA investment options. For instance, a bank may offer certificate of deposits as IRA investments; a mutual fund company will offer a variety of mutual funds from which to choose for investing your IRA; a brokerage firm, on the other hand, may offer you a self-directed IRA.

In a self-directed IRA, your investment options are many and varied. The only restriction is that you may not invest your IRA in collectibles. Should you invest an IRA in collectibles, the amount is considered distributed to you in the year you invested in them, and if you are under age 59.5, you may have to pay the 10% early-distribution penalty. Collectibles include the following:

Because your IRA assets could be vulnerable if you use them to complete certain transactions, you should know what these prohibited transactions are and their consequences. Your IRA disclosure statement, which must be provided to you when you establish your IRA, should include information about transactions that are considered prohibited, as well as any exceptions. When in doubt, be sure to check with your IRA custodian/trustee.

CHURCH BONDS. Mexican land. Pay telephones. Swiss annuities. Bus shelters. Gold coins. Paintings. Mortgages. Untraded stock. Bull sperm.

Bet you don't know which five of these ten assets are permissible investments in Individual Retirement Accounts.

In truth, probably 99% of the $2 trillion of IRA assets is invested in bank accounts, publicly traded stocks, bonds, funds and the like, and should be. "For most people, it's best to put the IRA either in mutual funds or stocks and bonds outright," says Robert Friedman, a lawyer with Holland & Knight in Miami.

But there are reasons to stray from the beaten path. People with their own export businesses can sometimes pull off a nifty trick that enables them to stuff $100,000 annually into their IRAs; to do that involves owning a strange asset in the account (see box, below). In other cases, emotional factors play a role. Church members may want to buy their own congregation's bonds. Goldbugs may want to stockpile bullion in the account.

If you're interested in unconventional assets, it's worth boning up on the rules, because most lawyers and IRA custodians have only partial knowledge.

In general, the law on IRA investments says not what you can do, but what you can't. First, there are entire classes of assets that are forbidden. A big one is collectibles: art, furniture, silver, numismatic coins, gemstones, jewelry, etc. Also verboten are life insurance, tangible personal property (like a car) and non-U.S. property, such as land in Mexico, though foreign stocks are okay.

Besides things you can't own, there are things you can't do, called prohibited transactions. These are forbidden relationships involving an IRA and its owner. If you blow any of these rules, your IRA is dead meat: It is taxable from the first day of the year when the mistake was made, no excuses allowed.

Examples? You may not use an IRA to secure a loan. Nor may you lend your IRA funds to any "disqualified person," which includes yourself, your parent (or other ancestor), your child or other lineal descendant, or descendant's spouse.

In fact, there can be no transaction between the IRA and such "disqualified persons." Thus you can't sell a piece of land that you own to your IRA for $40,000, even if that's the fair market value, or have your IRA buy stock in a company that you own 50% or more of. "This is often a problem for owners who want to get the stock of potential IPOs into their Roth IRAs," says Jeremiah Doyle, an IRA expert with Mellon Private Asset Management in Boston. "I've had to tell three owner/investors in different startups that it just wouldn't work for them."

What if you have a stake in a company, but don't control it? Then you may be able to invest IRA assets in it -- if your account is not self- directed and your investment is not too big a chunk of all your IRA assets. But the rules aren't clear, and Doyle recommends getting a private letter ruling from the IRS.

Beyond all these specifics, notes Grant Thornton partner Joan Vines, there is a general rule: You can't invest in something that benefits you now rather than in retirement. Thus, you can't use IRA funds to buy stock in a company so it will do business with you now.

Finally, an IRA can't own shares in a Subchapter S firm. And if it invests in another passthrough entity -- such as a partnership or LLC -- that contains an operating business, it will owe tax annually on any UBTI, Unrelated Business Taxable Income.

That's because Congress wants to keep businesses owned by tax- exempts -- a hospital eyeglass dispensary, for example -- from having unfair advantage over taxable competitors. So tax-exempts -- including your IRA -- owe tax on income from investments in operating businesses. Only income defined as "passive" is exempt, including rents (in some cases), royalties, dividends and interest.

So much for the Thou Shalt Nots, which still leaves you plenty of room to maneuver. Returning to our list above, FORBES found IRAs invested in church bonds, Swiss annuities, mortgages, gold and silver coins and bullion, and untraded stock. Also limited partnerships, venture capital funds, land and other real estate.

Of the five other items mentioned at the beginning of the story, only two are flat-out forbidden: Mexican land and paintings. The others -- pay telephones, bus shelters, bull sperm -- didn't qualify because IRA assets have to be held by qualified trustees or custodians, not individuals. No custodian that we know of is willing to take charge of bull sperm or pay phones, and the one peddling bus shelters was a sham.

This fact points up the real problem if you want to put unusual assets in your IRA: finding a custodian for the account, and at a reasonable price. Neither Fidelity, Vanguard nor Schwab will let you hold land in an IRA, for example.

Sometimes banks or brokers will agree to act as trustees for such assets. There are also institutions that specialize in them (see table).

Services and fees vary. Mellon, for example, charges an annual fee of 1% of the value of assets up to $3 million. But it requires the owner to supply the asset's value each year, which it must report to the IRS on Form 5498. If the owner doesn't provide the annual value, Mellon hires its own expert and charges the client.

By contrast, Denver's First Trust has a plan that charges a flat $40 per year plus $8 for each nonstandard asset. But this price usually includes the annual valuation.

Sometimes there are layers of fees. If you want to hold $20,000 of gold coins in an IRA at American Church Trust inHouston, which has many such accounts, you must pay an annual fee of $35 to do it. But you will also owe a flat $50 annual fee to Republic Bank in New York for storing the gold in its Manhattan vaults

Republic, by the way, provides the storage for every IRA custodian allowing precious metals that FORBES spoke with. It took over this business from a Delaware outfit in 1997 and roiled many goldbugs: Apparently these survivalist souls blanched at the thought of their gold residing in Manhattan, ground zero for a nuclear attack. Our advice to gold nuts: Consider having your IRA buy shares in Bank fr Internationalen Zahlungsausgleich at 9,000 Swiss francs per share. The bank owns a mound of gold stored in Switzerland and it also pays a nice dividend.

Custodians also differ as to which assets they will accept. American Church Trust, as the name implies, does a big business in church bonds.

Trustar Retirement Services in Wilmington, Del. is one of the few that take Swiss annuities -- no-load contracts from Swiss insurance firms payable in Swiss francs, which some consider a good inflation hedge. We think this investment is a comparatively dumb way to protect yourself from inflation -- why not buy an inflation-indexed U.S. Treasury yielding 3.9%? But if you must, there it is.

Is it legal to purchase non-standard assets like real estate by using my IRA?

Without question! The Employee Retirement Income Security Act of 1974 (otherwise known as ERISA), essentially passed the responsibility of retirement saving from the employer to the employee. IRAs were created in 1975 to provide individuals a chance to direct where their retirement funds were invested.

Rather than distinguishing which investments are allowed, the IRS code instead identifies which investments are not permitted under these laws. There are only two types of investments excluded under both ERISA and IRS Codes: Life Insurance Contracts and Collectibles such as works of art, rugs, jewelry etc. Refer to Internal Revenue Code Section 401 (IRC § 408(a) (3)).

Once ERISA was passed, the securities markets were responsible for bringing the IRA and 401(k) to the mass market. The banks and brokerage houses created a misconception that buying stocks, bonds and mutual funds was all that was allowed through retirement products such as an IRA. This is 100% false! Banks and brokerage houses have a vested interest in having you invest in stocks, bonds and mutual funds - not real estate, businesses and other non-traditional investments. Do not let the interests, or lack of knowledge of your financial advisor limit your ability to maximize the investment potential of your retirement accounts. There are many great brokers who understand that true diversification happens when your funds are invested in a variety of different markets. Guidant would be more than happy to introduce you to a professional who will be able to help truly diversify your IRA.

It must be noted that most employer sponsored plans such as a 401(k) will not let you roll your account into a new vehicle while you are still employed. However, some employers will allow you to roll a portion of your funds. The only way to be completely sure whether your funds are eligible for a rollover is by contacting your current 401(k) provider.

This is a difficult number to determine. However, the self-directed industry is growing at a rapid pace and is expected to see upwards of $2 trillion enter the market over the next two years. Some of the latest numbers show over 45 million IRA holders in the U.S. and less than 4% of those funds are held in non-traditional assets. This number is expected to increase significantly over the next 5 years as more and more individuals and their financial advisors attain a greater awareness of self-directed IRAs.

Yes. As discussed previously, you cannot invest in Collectibles or Life Insurance Contracts. In addition, there are certain transactions in which you cannot participate when using IRA funds. These are referred to as “prohibited transactions”. Prohibited Transactions are defined in IRC § 4975(c)(1) and IRS Publication 590. They were established to maintain that everything the IRA engages in is for the exclusive benefit of the retirement plan. Professionals often refer to these as “self-dealing” transactions. Self-dealing occurs when an IRA owner uses their individual retirement funds for their personal benefit rather than to benefit the IRA. As an IRA owner, if you violate these rules, your entire IRA could loose its tax-deferred or tax-free status. It is very important that you work with a competent Retirement Account Facilitator to help avoid violating these rules.

IRC § 4975(c) (1), identifies prohibited transactions to include any direct or indirect:

If you participate in a transaction which does not fit SPECIFICALLY within these guidelines, the Department of Labor or the IRS will analyze the specific facts and circumstances in order to decide whether you have engaged in a prohibited transaction. A Retirement Account Facilitator can help educate you regarding how these may apply to investment you are considering.

A plan is defined to include tax-qualified plans, IRAs and other tax favored arrangements. For the complete definition you can reference IRC § 4975(e) (1). A disqualified person (IRC §4975(e) (2)) is defined as:

These rules exist to ensure that your IRA does not engage in any investment activity other than for the exclusive benefit of the IRA. There are many types of investments which violate this law. For example, buying a house and then letting your mother rent it would potentially create a conflict of interests. If your mother, who was making rent payments, all of a sudden could not – you would be conflicted from evicting her and finding a more reliable tenant. You would then have a conflict of interest between your relationship with your mother and what is in the best interest of your IRA. These rules were put in place to help avoid these sort scenarios. See IRC § 408

If my brother in not a disqualified party then can I buy a house and let him rent it from me?

Theoretically yes. Your brother is not a disqualified person. However just like the scenario mention above, if he occupied a rental property owned by your IRA and could not make the payments-you could run afoul of the exclusive benefit rule. This could cause your IRA to have participated in a prohibited transaction. It is important that you treat every investment the same – to benefit your IRA and only the IRA.

If an IRA holder is found to have engaged in a prohibited transaction with IRA funds, it will result in a distribution of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred.

As mentioned previously, the IRS does not identify what investments or transactions you can make in your IRA. They instead state which investments are prohibited and what makes certain transactions prohibited. Identifying, interpreting and following these rules are complicated but not impossible. As a Retirement Account Facilitator, Guidant Financial Group can help you follow Internal Revenue guidelines and steer clear of prohibited transactions.

It may be they are influenced by self interest or they are simply uninformed. Often times an individual will ask their CPA, Attorney or Financial Planner for advice and in turn are told: "That’s illegal." "You can’t do that." "It is very risky." Attorneys stick to their core competencies and rarely deviate from them: Tax preparers are taught to do just that - prepare taxes. Your financial advisor’s company or agency may either be disinterested in this type of business or have not been educated regarding this type of investing format: A stock broker makes money when they sell stocks, bonds and mutual funds - not real estate.

Guidant’s Professional Network understands and embraces the self-directed industry. Use this area of our Web site to find professionals available to you in the self-directed industry.

The custodian is a bank or savings and loan institution, as defined in IRC § 408(n), or any other entity that has the approval of the IRS to act as custodian. In order to have a self-directed IRA, it needs to be held with a custodian who will allow investments into non-traditional investments. There are very few of these types of custodians.

There are very few non-traditional IRA custodians simply because the business is not as profitable as it is for the brokerage houses. It requires many more hours to complete a real estate transaction than to purchase stocks over an electronic system. Traditional banks do not compete because it does not fit within their business objectives. They make money by leveraging the dollars you have sitting in their accounts.

In order to work with Guidant, a custodian must be a registered Trust Company. For one to register as a Trust Company the institution must meet stringent state requirements and have adequate reserves. Your money is kept in a separate account for your benefit and not subject to creditors of the custodian. Further, under Guidant’s programs, the custodian never has control of your money—YOU DO! You are ALWAYS in control.

You are charged a fee for simply having an account with a custodian each year. A custodian generates revenue in a variety of ways:

Asset fees are typically based off a percentage of the value of your self-directed IRA. As your IRA continues to increase in value, they are able to charge you more – even if you never purchase an asset. Larger accounts are penalized under this system.

Transactional fees apply when your IRA purchases an asset. In regards to real estate, there can be fees assessed for wiring an escrow deposit; fees for reviewing a purchase and sale; fees for recording each document, and fees for the final wire of funds to complete the purchase. The process repeats itself when you sell that asset. This can add up quickly for active investors.

Holding fees are also assessed for assets that are held with a custodian. If your IRA purchased a piece of real estate, the custodian could assess a quarterly fee for just holding the deed on behalf of your IRA.

Special fees include things like expediting service, express mail, wire funds and so on. Special fees can add up quickly especially when trying to close transactions quickly.

No. Guidant Financial Group is the largest Retirement Account Facilitator in the nation. As a Retirement Account Facilitator, we ensure that our clients are compliant with the rules and regulations set forth by the IRS and Department of Labor. In this way their retirement funds are safe from penalties and tax consequences.

A Retirement Account Facilitator makes investing through self-directed IRAs simple and cost effective for its clients. Additionally, Guidant Financial Group is not bound to offer just one product or service, so we are able to consult with you to help determine which self-directed structure or account is best for your investment objectives.

Guidant’s clients do not pay asset fees, holding fees or transactional fees. They simply pay one small fee to a custodian each year – regardless of the size of their account. Because of the volume of people using Guidant to facilitate their self-directed structures, we have been able to secure the lowest rate available for all self-directed participants. Other benefits may include, but are not limited to, having checkbook control to make timely investments, further insulation for asset protection purposes and access to one of the nation's largest self-directed Professional Networks.

As a Retirement Account Facilitator we need to make sure you understand all of your options. Click here to see how you can get started with self-directed investing.

As a Guidant client, am I limited in which types of investments I would be able to participate?

Guidant continues to deal with a wide variety, and different types of investments. Some the more common include:

That depends. Working with a traditional self-directed IRA custodian makes investments like tax liens, foreclosure homes and real estate difficult. With a traditional self-directed IRA custodian, the client cannot have any personal interaction with the IRA funds. They have to petition the IRA custodian to make an investment on their behalf. Banks move at a pace much slower than the investment community – often times it can take weeks to complete a transaction.

On the other hand, Guidant Financial Group’s clients benefit from having complete “check-book” control and immediate access to their retirement funds, so they CAN participate in such transactions quickly and efficiently!

Even though there are companies which claim you can - this is strictly forbidden under IRC § 4975. There are many great real estate transactions available so do not put your retirement account at risk by engaging in a "self-dealing" transaction such as this.

If I have a 401(k) with my current employer, will I be able to use these funds to purchase non-standard assets?

Perhaps. If your company has a self-directed 401(k) like the ones Guidant establishes then yes. Most employers do not have a self-directed 401(k) so there is a high probability that it will not be possible. The only way to be sure is to contact your current 401(k) administrator.

Yes! Leverage is a very powerful tool when purchasing real estate. However, there are complications when using a self directed IRA and leverage. The "prohibited transaction" rules state that you as a disqualified person cannot extend credit to an IRA or IRA asset. This means that if your IRA gets a loan on a piece of real estate - you cannot personally guarantee the loan. This would be viewed as extending credit. Refer to IRC § 4975(c) (1) (B) for more specific information.

An IRA must secure what is called a non-recourse loan. This type of loan is given solely based on the property. A bank who lends money to the property is lending money based on the investment rather than lending to a borrower who has a great credit score. Because banks do not have any recourse against the IRA or IRA holder, they typically require a high down payment. In the past we have seen banks require 50% down with marginally high interest rates. Banks are not in the business of foreclosing on homes, so they need to make sure if your self-directed IRA cannot make the payments that it is in a protected position and will not lose its investment.

To rectify this type of situation, Guidant Financial Group has built a working relationship with a national banking institution which will require as little as 30% down with very reasonable interest rates for non-recourse loans in all 50 states.

Yes you can. Guidant Financial Group is a Retirement Account Facilitator. Because of this, we are able to offer many more options than a self-directed IRA custodian. Our business is to make this process simple to establish, easy to understand and effortless to maintain. However, we do not suggest you use a self-directed IRA to purchase a business. Plans such as IRAs and 401(k) which engage in business activity generate Unrelated Business Taxable Income (UBTI).

To alleviate this situation, Guidant uses the Entrepreneur Pension™ when a retirement account is going to purchase a business because this structure does not generate UBTI.

UBTI is an acronym for Unrelated Business Taxable Income. UBTI generally occurs when a plan generates income from operating a business, acquiring or improving property through debt financing, or certain partnerships from which the plan owns an interest.

UBTI is income generated by a trust when engaging in business activity that is unrelated to its general purpose. Self-directed IRAs were created for long term investing, and when it purchases an asset that produces income unrelated to the intent of the “plan” then that income is subject to taxation – which means your IRA will be paying taxes on profits generated from your business purchase.

UBTI is subject to Unrelated Business Income Tax or UBIT. UBIT is a very steep and complicated form of taxation. Much like Federal Income Taxes, UBIT is set to a laddered schedule. However it is compressed on much tighter levels. In 2005, UBIT is taxed at the following rates:

UBIT was implemented to keep the playing field even between plans that open businesses and the typical small business owners. If a plan or self-directed IRA was able to purchase a business and did not have to pay any taxes, it would be able to deliver an identical product at a discount. UBIT mitigates that risk for the typical business owner.

UBIT is one of the most complicated areas of taxation in the Internal Revenue Code. It is imperative you seek professional help to make sure you do not incur any severe tax penalties.

UDFI stands for Unrelated Debt Financed Income. UDFI is income generated by an IRA, or other retirement plans, through debt-financing or leverage. UDFI is taxed much like UBTI and is similarly as complicated. UDFI only applies to the profit realized through debt and is based on the highest amount of leverage carried within the past 12 months. Refer to IRC § 514(a) (1).

For example: Your self-directed IRA purchased a piece of raw land in 1999 for $100,000 using a non-recourse loan with 50% down. In 2004, you sold that same piece of property to a developer for $200,000. Your IRA had secured a 50% loan to value (LTV) on the property, and let’s assume that you never paid down any principle because it was an interest only note. Fifty percent of the profit would be subject to UBIT because it was generated by money that was not related to the self-directed IRA.

As a side note – UDFI does not apply if the debt is paid off 12 months prior to the sale of the property. If the self-directed IRA can pay off its loan early – it may not have to pay UBIT at all! If you are intending to purchase assets inside a self-directed IRA using debt-financing, please consult with a competent tax advisor.

If you have a “traditional” self-directed IRA then the answer is no. Using Guidant’s Truly Self-Directed IRA, you can manage the property, collect the rent, screen tenants, perform general maintenance, and more. This can save your IRA hundreds of dollars each month and ultimately provide more investment capital available.

Can I mix personal funds with IRA funds to purchase a piece of real property?

Yes, if it is structured correctly. You must be very careful to whom you are listening. The prohibited transactions code prohibits an individual from using personal or IRA cash to benefit the other. This can be easily violated through “formation issues”. If you are considering using your personal funds to invest in real estate with your IRA either through Tenant-in-Common or a Partnership Entity, consult with Guidant Financial Group first. Do not be a test case for an inexperienced professional.

How do I find a realtor, CPA or mortgage lender in my area who knows about self-directed IRAs?

Guidant Financial Group understands the difficulties in finding competent professionals who understand and embrace the self-directed industry. After registering with Guidant, users have access to Guidant’s Professional Network and can contact an advisor in their area.

A qualified plan almost always will be subject to regulation under ERISA's labor provisions. Those provisions apply to every "employee benefit plan" unless an exemption applies. An "employee benefit plan" includes a "pension plan," defined as any plan, fund or program maintained by an employer or an employee organization which provides retirement income for employees or which results in a deferral of income by employees until termination of employment or later. 10 The plan must be established or maintained by an employer engaged in interstate commerce or in an industry or activity affecting interstate commerce, or by an employee organization (i.e., union) representing employees engaged in commerce or in an industry or activity affecting interstate commerce. 11
/Footnote/ 10 ERISA §3(2)(A).
/Footnote/ 11 ERISA §4(a).

Part 4 of Title I of ERISA sets forth the fiduciary duties described below.
1. Exclusive Benefit of Employees
A fiduciary must discharge his or her duties with respect to the plan solely in the interest of the plan's participants and beneficiaries. 35 In other words, the fiduciary's allegiances are to the participants and beneficiaries only. A fiduciary cannot make decisions with a view toward protecting the interests of any other party, including the fiduciary's own interests.
/Footnote/ 35 ERISA §404(a)(1).

In discharging its duties, the fiduciary must use the "care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." 47 By referring to one who is "familiar with such matters," the statute imposes the standard of a prudent expert, not that of a prudent layman whose failure to act with care and skill can be excused merely because the average layman would have done no better.
/Footnote/ 47 ERISA §404(a)(1)(B). See Farr v. U.S. West, Inc., 815 F. Supp. 1364 (D. Or. 1992), aff'd in part, rev'd in part, 58 F.3d 1361 (9th Cir. 1995), in which the court held that pension plan trustees did not breach fiduciary duties by deciding not to address §415 limitations in plan amendment materials, offering early retirement option to eligible employees, because their actions fell well within the prudent man standard and the general duty to act in the interests of plan participants. The court explained that the trustees' decision was the product of an estimate not borne out, i.e., that only an insignificant number of employees would be affected and was, at most, a tactical error in judgment mitigated by the fact that they cautioned the employees to seek independent financial and tax advice. In addition, the court found that the trustees' decision to mitigate the impact of the §415 limit on employees, by lowering the discount rate, was: (1) made in the interests of plan participants who were compensated for the losses on their future income stream; and (2) to the detriment of the employer who made the increase in excess benefit payments from corporate assets.
Under the Department of Labor's regulations relating to the investment duties, a fiduciary satisfies ERISA's duty of prudence by giving "appropriate consideration" to the facts and circumstances that, given the scope of the fiduciary's investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action. This duty extends to the role the investment or investment course of action plays in the plan's investment portfolio. 48
/Footnote/ 48 Labor Regs. §2550.404a-1(b)(1).
3. Diversification
A fiduciary must "diversify the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so." 49 Of course, only fiduciaries having authority with respect to investments of the plan will be directly responsible for this duty. For such fiduciaries, the requirement that they discharge their duties with care and prudence arguably already requires them to select a diversified portfolio. By making diversification a separately enumerated fiduciary duty, the statute indicates the important role that investment diversification plays in the protection of the retirement income. The statute permits some flexibility if this is prudent. For instance, a particular investment might be so secure and yield such a high rate of return that further diversification is not needed to protect the plan against the risk of a large loss.
/Footnote/ 49 ERISA §404(a)(1)(C).
Certain individual account plans (i.e., defined contribution plans) need not diversify their investments if they invest in securities of the employer or real property that is rented by the plan to the employer, provided certain other conditions are met. 50 Thus, in general, a plan may not acquire qualifying employer securities or qualifying employer 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 plan's assets. 51 However, these restrictions do not apply to an eligible individual account plan, 52 e.g., a defined contribution plan, that is:
• a profit-sharing, stock bonus, thrift or savings plan;
• an employee stock ownership plan; or
• a pre-ERISA money purchase plan. 53
/Footnote/ 50 ERISA §404(a)(2). See, e.g., Steinman v. Hicks, 352 F.3d 1101, 31 EBC 2415 (7th Cir. 2003).
/Footnote/ 51 ERISA §407(a)(2); DOL Regs. §2550.407a-2.
/Footnote/ 52 ERISA §407(b)(1).
/Footnote/ 53 ERISA §407(d)(3)(A).
In addition, the plan must explicitly provide for the acquisition and holding of qualifying employer securities or qualifying employer real property and may not supply benefits that serve to alter benefits accorded under a defined benefit plan. 54
/Footnote/ 54 ERISA §407(d)(3)(B).
With certain exceptions, effective for elective deferrals for plan years beginning after December 31, 1998, companies no longer can require employees to invest more than 10% of their §401(k) plan contributions in qualifying employer securities or qualifying employer real property under the terms of the plan or at the direction of anyone other than the participant or beneficiary. 55 The rule (known as the " §401(k) diversification rule") does not apply to an individual account plan if the fair market value of the assets of all individual account plans maintained by the employer does not exceed 10% of the fair market value of the assets of all retirement plans maintained by the employer. Multiemployer plans are not taken into account for this purpose. 56 The rule also does not apply to an employee stock ownership plan (ESOP). 57
/Footnote/ 55 ERISA §407(b)(2)(A) and (B)(i), enacted by P.L. 105-34, §1524.
/Footnote/ 56 ERISA §407(b)(2)(B)(ii).
/Footnote/ 57 ERISA §407(b)(2)(B)(iii).
The §401(k) diversification rule also does not apply to an individual account plan if, pursuant to the terms of the plan, the portion of any employee's elective deferrals which is required to be reinvested in qualifying employer securities or qualifying employer real property does not exceed 1% of a participant's compensation. 58
/Footnote/ 58 ERISA §407(b)(2)(B)(iv); H.R. Conf. Rep. No. 220, 105th Cong., 1st Sess. 750 (1997).
Note: Employees may elect (i.e., in participant-directed individual account plans) to invest more than 10% of their elective deferrals in qualifying employer securities and employer real property, and employers still can invest their matching contributions in qualifying employer securities or employer real property. In addition, the assets invested in qualifying employer securities and qualifying employer real property above the 10% limitation qualify for the protection from the fiduciary duty rules afforded to participant-directed accounts. 59
/Footnote/ 59 See ERISA §404(c).

5. Transfer of Assets Outside of the United States
A fiduciary may not maintain the indicia of ownership of any plan assets outside the jurisdiction of the United States district courts, except as permitted by Labor Department regulations. 63
/Footnote/ 63 ERISA §404(b).
6. Not to Cause Plan to Enter into Prohibited Transactions
In addition to the general fiduciary duties listed above, certain transactions are prohibited between a plan and certain other persons having a relationship with the plan. Although the focus of most of those rules is upon the "party in interest" engaged in the transaction with the plan (because that person is subject to civil penalties or excise taxes), the fiduciary is affected by the prohibited transaction rules because the fiduciary acts on behalf of the plan in the transaction. It is a breach of fiduciary duty to cause a plan to engage in a transaction if the fiduciary knows, or should know, that the transaction is with a party in interest and is one of the types of prohibited transactions described in the statute (such as a sale or exchange). 64
/Footnote/ 64 ERISA §406(a)(1).
The U.S. Supreme Court ruled unanimously that a non-fiduciary party in interest may have civil liability for involvement in a prohibited transaction. 65 The court concluded that ERISA imposes a duty, for the purpose of redressing violations or enforcing any provisions of ERISA or of a plan, on non-fiduciary parties in interest that is separate and distinct from other duties imposed by the statute. 66 For more information of parties in interest, see ¶5530.03.A., below.
/Footnote/ 65 Harris Trust and Savings Bank v. Salomon Brothers Inc., 120 S. Ct. 2180, 24 EBC 1654 (2000).
/Footnote/ 66 Harris Trust and Savings Bank v. Salomon Brothers Inc., 120 S. Ct. 2180, 24 EBC 1654 (2000). See ERISA §§406(a) and 502(a)(3)
Fiduciaries also breach their duties by engaging in other types of prohibited transactions, such as self-dealing.
¶5530.02.C. Liability for Breach
Statutory remedies are provided for parties aggrieved by a fiduciary's breach of duty. In particular, ERISA allows a civil suit to be brought against the breaching fiduciary.

¶5530.03.A. Party in Interest and Disqualified Person Defined
Two key terms in the prohibited transaction area are "party in interest" (used by ERISA) and "disqualified person" (used by the tax Code). These are the persons who may not engage in certain transactions with a plan. The terms are substantially similar. A party in interest is a party who is any of the following:
(1) a fiduciary, counsel, or employee of the plan;
(2) a person providing services to the plan;
(3) an employer any of whose employees are covered by the plan;
(4) an employee organization (i.e., union) any of whose employees are covered by the plan;
(5) an owner (directly or indirectly) of a 50% or more interest in an employer or an employee organization described in paragraphs (3) or (4) above, in terms of: (i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation, (ii) the capital interest or the profits interest of a partnership, or (iii) the beneficial interest of a trust or unincorporated enterprise;
(6) a relative of any individual described in (1), (2), (3) or (5) above;
(7) a corporation, partnership, trust, or estate of which (or in which) 50% or more is owned (directly or indirectly) or held by persons described in (1), (2), (3), (4) or (5) above, in terms of: (i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation, (ii) the capital interest or profits interest of such partnership, or (iii) the beneficial interest of such trust or estate;
(8) an employee, officer, director (or an individual having similar powers or responsibilities) of a person described in (2), (3), (4), (5) or (6) above or of the plan (see further discussion below);
(9) a 10% or more shareholder (directly or indirectly) of a person described in paragraphs (2), (3), (4), (5), or (6) above; or
(10) a 10% or more (directly or indirectly in capital or profits) partner or joint venturer of a person described in paragraphs (2), (3), (4), (5), or (6) above. 99
/Footnote/ 99 ERISA §3(14)(A) through (I); Code §4975(e)(2)(A) through 4975(e)(2)(I). A corporation that is formed to provide administrative services to two multiemployer plans that are a "related group of plans" for purposes of the plan assets regulation under DOL Regs. §2510.3-101(h)(3), and that is owned entirely by those plans, should be viewed as an asset of those plans and, thus, would not be a party in interest with respect to the plans. DOL Adv. Op. 2005-03A.
In paragraph (8) above, the tax Code definition of disqualified person limits the definition of "employee" to "a highly compensated employee (earning 10% or more of the yearly wages of the employer)." 100 ERISA does not contain this limitation. The Code's definition does not include counsel or employees of the plan itself. 101 Finally, the Code does not include references to service providers in paragraphs (8), (9), and (10). 102
/Footnote/ 100 Code §4975(e)(2)(H).
/Footnote/ 101 Compare §4975(e)(2)(A) with ERISA §3(14)(A).
/Footnote/ 102 Compare §4975(e)(2)(H) and (I) with ERISA §3(14)(H) and (I).
¶5530.03.B. Kinds of Prohibited Transactions
Both the Code and ERISA prohibit the following transactions between the plan and certain persons (the term "party in interest" applies under ERISA, "disqualified person" is used in the Code):
• a sale or exchange, or leasing, of any property between the plan and a party in interest; 103
• lending money or other extension of credit between the plan and a party in interest; 104
• furnishing goods, services, or facilities between the plan and a party in interest; 105
• transfer to, or use by or for the benefit of, a party in interest, of any assets or income of the plan; 106
• an act by a fiduciary whereby the fiduciary deals with the assets or income of the plan in his or her own interest or for his or her own account (i.e., self-dealing); 107 or
• receipt of consideration by a fiduciary for his own account from any party dealing with the plan in connection with a transaction involving the assets or income of the plan (i.e., a kickback). 108
/Footnote/ 103 ERISA §406(a)(1)(A); Code §4975(c)(1)(A).
/Footnote/ 104 ERISA §406(a)(1)(B); Code §4975(c)(1)(B). This means that loans from a plan to a disqualified person are prohibited as well as loans by a disqualified person to a trust. See Janpol v. Comr., 101 T.C. 518 (1993). Guarantees made by a disqualified person on behalf of a plan are considered an extension of credit by the disqualified person to the trust. Id.
/Footnote/ 105 ERISA §406(a)(1)(C); Code §4975(c)(1)(C). In DOL Adv. Op. 2005-03A, the Labor Department addressed the case in which a corporation is owned entirely by a related group of plans (here, multiemployer teamster funds) under DOL Regs. §2510.3-101(h)(3) and is formed to provide administrative services to those funds and to other plans. The DOL advised that once the corporation begins to provide administrative services, transactions between the corporation and the funds would not be considered prohibited transactions, instead they would be treated as "intra plan" transactions. However, once the corporation begins to provide services to another plan, the corporation and the funds become parties in interest with respect to the plan. Thus, fiduciaries of the plan engage in a prohibited transaction by obtaining services from the corporation and by using plan assets to pay for those services unless a statutory or administrative exemption applies.
/Footnote/ 106 ERISA §406(a)(1)(D); Code §4975(c)(1)(D); Harris v. Comr., T.C. Memo 1994-22 (Use of IRA account to acquire property solely for purpose of providing account owner with personal residence violates §4975(c)(1)(D)). Use of a plan's assets may violate §4975(c)(1)(D) even if none of the assets are transferred directly to the disqualified person. See, e.g., Etter v. J. Pease Constr. Co., 963 F.2d 1005, 15 EBC 1741 (7th Cir. 1992); Rollins v. Comr., T.C. Memo 2004-260 (Loans from §401(k) plan of company wholly-owned by plan fiduciary to entities partially owned by fiduciary were prohibited transactions regardless of whether fiduciary personally benefited). Conversely, the receipt of an incidental benefit by a disqualified person does not necessarily violate §4975(c)(1)(D). See, e.g., TAM 9516005 (Acquiring company derived incidental benefit from use of acquired company's plan assets following merger of plans, but transaction did not violate §4975(c)(1)(D) since direct beneficiaries of use of plan assets were plan participants and beneficiaries).
/Footnote/ 107 ERISA §406(b)(1); Code §4975(c)(1)(E).
/Footnote/ 108 ERISA §406(b)(3); Code §4975(c)(1)(F). In DOL Adv. Op. 2005-10A, the Labor Department advised that a bank that serves as a plan trustee and custodian of IRAs that participate in a model investment strategy program, and as an investment adviser and custodian for mutual funds in which the IRA assets are invested, avoids violations of Code §4975(c)(1)(E) or (F) if the management fees that the bank receives from the IRAs are reduced by the amount of advisory and non-advisory fees it receives from the mutual funds, and the receipt of fees from the funds does not cause the bank's compensation to exceed the amount of management fees agreed to by the IRA holder. In DOL Adv. Op. 2004-09A, the Labor Department advised that contributions of cash credits by insurers and banks to an accountholder's HSA are not prohibited transactions under Code §4975(c)(1) and ERISA §406(a)(1) and (b). In the advisory opinion, an insurer offered HSAs to individuals covered by high deductible health plans issued by the insurer or entered into a contractual agreement with a bank that offered HSAs to eligible individuals. In either case, an incentive in the form of a cash credit contribution of $100 was made to the accountholder's HSA upon the establishment of the HSA. Further, with respect to cash credit contributions made by the bank, the same result in Adv. Op. 2004-09A applies to an HSA that would be an employee benefit plan covered under Title I of ERISA under the principles discussed in Field Assistance Bulletin 2004-01, in which the DOL concluded that generally HSAs do not constitute employee welfare benefit plans for purposes of ERISA. In instances in which an HSA is covered under ERISA, the fiduciary duties under ERISA §404 apply to the selection of service providers of the HSA. DOL Adv. Op. 2004-09A.
Note: An exemption may be available for certain prohibited transactions, as discussed at ¶5530.03.C, below.
The transfer of real or personal property to a plan by a party in interest is treated as a sale or exchange if the property is subject to a mortgage or similar lien that the plan assumes or that a party in interest placed on the property within the 10-year period ending on the date of the transfer. 109 The definition of a prohibited sale or exchange is interpreted broadly to include all transfers of encumbered property to a plan, whether or not in discharge of a debt, because transfers of encumbered property raise a significant potential for abuse. 110 Further, the transfer of unencumbered property to a qualified plan is a sale or exchange subject to excise tax only if the transfer satisfies a plan funding obligation. 111
/Footnote/ 109 ERISA §406(c); Code §4975(f)(3).
/Footnote/ 110 Keystone Consol. Indus., Inc. v. Comr., 113 S. Ct. 2006, 16 EBC 2121 (1993), rev'g 951 F.2d 76, 14 EBC 2284 (5th Cir. 1992).
/Footnote/ 111 Id. See also Wood v. Comr., 955 F.2d 908, 14 EBC 2401 (4th Cir. 1992). In Keystone Consol. Indus., Inc. v. Comr., 113 S. Ct. 2006, 16 EBC 2121 (1993), the U.S. Supreme Court ruled that the contribution of property in satisfaction of a funding obligation is both an indirect type of sale and a form of exchange since the property is exchanged for diminution of the employer's funding obligation. Thus, an employer with no outstanding funding obligations may contribute unencumbered property to a plan if, for example, it wants to reward its employees for a particularly productive year.
Unless a statutory or administrative exemption under ERISA applies, in-kind contributions to defined benefit plans, defined contribution plans, and welfare benefit plans are prohibited transactions if they reduce an obligation to make a contribution that is measured in terms of cash amounts. 112
/Footnote/ 112 The Department of Labor provides guidance on contributions of property rather than cash to defined benefit plans, defined contribution plans and welfare plans. See DOL Regs. §2509.94-3.
Recognizing that many employers have made contributions of unencumbered property in a form other than cash or its equivalent to qualified defined benefit plans and to qualified defined contribution plans in satisfaction of obligations to those plans, the IRS provided relief from the additions to tax for employers that have satisfied certain conditions. 113
/Footnote/ 113 See Announcement 95-14, 1995-8 I.R.B. 47.
In addition, ERISA (but not the Code) defines as a prohibited transaction a fiduciary acting, in an individual or other capacity, in a transaction involving the plan if the fiduciary acts on behalf of (or represents) a party whose interests are adverse to those of the plan or its participants or beneficiaries. 114 Further, ERISA defines as a prohibited transaction the acquisition on behalf of a plan of any securities of the employer (or an affiliate) or real property rented by the plan to the employer (or an affiliate) if such an acquisition violates ERISA's rules governing the holding of such assets. 115 In general, a plan may not invest more than 10% of its total assets in such securities or real property unless the plan is a profit-sharing plan, stock bonus plan, or an ESOP. 116
/Footnote/ 114 ERISA §406(b)(2). In DOL Adv. Op. 2005-04A, the Labor Department advised that a plan trustee who is a significant owner and the president and chief executive officer of a fund's investment advisor will violate ERISA §406(b) if he uses any of the authority, control, or responsibility that makes him a fiduciary to cause the plan to invest in that fund.
/Footnote/ 115 ERISA §406(a)(1)(E).
/Footnote/ 116 See ERISA §407(a)(2).
The 10% limitation also applies to investments by pension plans in qualifying employer securities and employer real property and also extends to elective deferrals under §401(k) plans. 117
/Footnote/ 117 ERISA §407(b)(2).
¶5530.03.C. Exemptions
1. Statutory Exemptions
By statute, certain transactions are not considered prohibited. The principal statutory exemptions are described below. Unless otherwise noted, these exemptions apply both for purposes of the Code and ERISA.
a. Loans to Participants
A plan may make a loan to a participant or beneficiary (even though such person might otherwise be a party in interest or disqualified person) if five conditions are met. Loans must:
• be available to all participants or beneficiaries on a reasonably equivalent basis (see below);
• not be made available to highly compensated employees 118 in an amount greater than is made available to other employees;
• be made in accordance with specific plan provisions;
• bear a reasonable rate of interest; and
• be adequately secured. 119
/Footnote/ 118 Within the meaning of Code §414(q).
/Footnote/ 119 ERISA §408(b)(1); Code §4975(d)(1). These rules apply in addition to the Code §72(p) rules governing the tax treatment of loans from qualified plans, which are discussed in ¶5550. See EBSA FAB 2003-1 (Participant loans can be denied to officers and directors without violating ERISA §408(b)(1)(A) requirement that loans be available to all participants and beneficiaries on reasonably equivalent basis).
The Labor Department regulations govern loans from qualified plans to participants and beneficiaries. 120 The regulations provide that the requirement that loans be made on a "reasonably equivalent basis" means that the loans must be made on a nondiscriminatory basis, taking into account factors that would be considered by a lender in a normal commercial setting. They also provide that an employer may not require a minimum loan amount of more than $1,000. The regulations stipulate that plan loans must be made in accordance with the plan document, even though they do not have to be written into that document.
/Footnote/ 120 DOL Regs. §2550.408b-1.
Loans must be adequately secured by the plan. The regulations provide, however, that not more than 50% of the present value of the participant's vested accrued benefit may be used as security. The regulations interpret a "reasonable rate of interest" to mean that the return must be equivalent to the interest rates that would be charged by individuals engaged in the business of lending money under similar circumstances. The regulations provide no safe harbors or methods to determine what the prevailing interest rate should be for similar loans.
b. Loan to an Employee Stock Ownership Plan (ESOP)
A loan to an ESOP made by, or guaranteed by, a party in interest (such as the sponsoring employer) is not a prohibited transaction if certain conditions are met. The loan must be primarily for the benefit of participants and beneficiaries and the interest rate cannot exceed a reasonable rate. If the ESOP gives collateral for such a loan, the collateral may consist only of certain types of securities of the employer. 121 This exemption enables loans to be made to "leveraged" ESOPs, under which the sponsoring employer typically provides a third-party lender with its guarantee that the loan will be repaid by the employer if the plan defaults. Such a guarantee would be a prohibited extension of credit by the employer on behalf of the plan absent this exemption.
/Footnote/ 121 ERISA §408(b)(3); Code §4975(d)(3). See PLR 9522041 (Payment of performance dividends by employer to ESOP does not result in ESOP being treated as engaging in a prohibited transaction due to violation of Code §4975(d)(3) provided ESOP uses such dividends to make payments on ESOP loan); PLR 9530023 (Employer's refinancing of bank loan, which was used by its ESOP to purchase employer stock, as part of financing to build new factory is consistent with primary benefit requirement); TAM 9624002 (Termination of troubled ESOP loan and employer's acquisition of unallocated shares when taxpayer was unable to find alternative financing did not violate primary benefit rule and was not prohibited transaction); PLR 9736018 (Corporation's return of invested capital to ESOP, which had originally borrowed the capital from corporation, did not trigger excise tax on prohibited transactions if distribution was reinvested in corporation's stock within a reasonable time); PLR 200147056 (Prepayment of ESOP loan to facilitate merger of plans did not violate primary benefit rule and was not prohibited transaction); PLR 200321020 (Use of sale proceeds from sale of stock held by ESOP to repay §4975(d)(3)(A) exempt loan does not result in prohibited transaction), PLR 200408032 (Same in connection with termination of plan for business and financial reasons).
Because ESOPs are qualified plans, such a loan can be made only if the ESOP meets certain requirements of the Code which are not contained in ERISA's labor provisions. 122
/Footnote/ 122 See discussion in ¶5520 and ¶5560.
An ESOP would not violate the plan qualification rules or be considered to have engaged in a prohibited transaction due to a distribution with respect to S corporation stock that constitutes "qualifying employer securities" that is used to make loan repayments (interest and principal) to a leveraged ESOP , the proceeds of which were used to acquire such securities (whether or not allocated to participants). 122.1 The provision does not apply however, in the case of a distribution that is paid with respect to any employer security that is allocated to a participant unless the plan provides that employer securities with a fair market value not less than the amount of such distribution are allocated to such participant for the year that such distribution would have been allocated to such participant but for the loan repayment distribution.
/Footnote/ 122.1 Code §4975(f)(7), added by the American Jobs Creation Act of 2004 (AJCA), Pub. L. 108-357, §240(a), applicable with respect to distributions of S corporation stock made after Dec. 31, 1997.
c. Service as Fiduciary in Addition to Being a Representative of a Party in Interest
An individual may serve as a fiduciary even though the individual also serves as an officer, employee, agent, or other representative of a party in interest or disqualified person. 123 For example, the president of the employer sponsoring a plan may serve as the plan's trustee or administrator.
/Footnote/ 123 ERISA §408(c)(3); Code §4975(d)(11).
d. Receipt by Fiduciary or Disqualified Person of Plan Benefits
An individual who is a fiduciary or disqualified person may receive benefits to which he or she is entitled as a participant or beneficiary, so long as the benefits are computed and paid on a basis that is consistent with the plan's terms as applied to other participants and beneficiaries. 124
/Footnote/ 124 ERISA §408(c)(1); Code §4975(d)(9). Note, however, that Code §401(a)(13)(C) as added by the Taxpayer Relief Act of 1997 (P.L. 105-34, §1502(b)) allows qualified retirement plans to offset a participant's liability for certain breaches of fiduciary duty against the participant's plan benefit if certain requirements are met. This provision is optional and applies to judgments, orders and decrees issued, and settlement agreements entered into, on or after August 5, 1997.
e. Furnishing Space, Services, Etc. to Plan by Party in Interest
A party in interest or disqualified person may contract with a plan for the provision of office space or legal, accounting, or other services necessary for the plan's establishment or operation if no more than reasonable compensation is paid. 125 This exemption, for example, allows a plan administrator, investment manager, or trustee to share office space with the plan to promote its effective operation.
/Footnote/ 125 ERISA §408(b)(2); Code §4975(d)(2). If a broker-dealer's registered representative operates on the premises of a credit union that provides investment options to individual account plan participants, and the representative executes trades in mutual funds and insurance products at the direction of plan participants but does not provide investment advice to the plan or its participants, the representative is not prohibited by ERISA §406(a) from engaging in those activities if all of the conditions of ERISA §408(b)(2) are satisfied. DOL Adv. Op. 2005-11A.
f. Acquisition or Sale of Qualifying Employer Securities or Qualifying Employer Real Property
Although it is a prohibited transaction for an employer or certain of its affiliates to buy from, or sell to, a plan sponsored by the employer, ERISA and the Code exempt certain such purchases or sales in order to facilitate plan investments in some kinds of employer securities or in real property leased to the employer. It is not a prohibited transaction for a plan to acquire or sell "qualifying employer securities" or to acquire, sell, or lease "qualifying employer real property" if the following conditions are met:
• the acquisition, sale, or lease is for adequate consideration; 126
• no commission is charged to the plan with respect to such transaction; and
• the plan is an "eligible individual account plan" (see below) or the lease or acquisition is not prohibited by ERISA §407(a). 127
/Footnote/ 126 Adequate consideration must be based on a good faith estimate. In one case, an employer was not permitted to rely on the valuation set by an underwriter for a proposed public offering of employer securities that had been canceled because the evidence indicated that the circumstances had changed by the time the securities at issue were sold to the plan. See Eyler v. Comr., T.C. Memo 1995-123, aff'd, 88 F.3d 445, 20 EBC 1552 (7th Cir. 1996).
/Footnote/ 127 ERISA §408(e); Code §4975(d)(13).
In general, an eligible individual account plan is a profit-sharing plan, thrift plan, stock bonus plan, or an ESOP that explicitly provides for the acquisition and holding of qualifying employer securities or qualifying employer real property. 128
/Footnote/ 128 ERISA §407(d)(3).
Qualifying employer securities are securities issued by an employer to employees covered by the plan or by an affiliate of such an employer that are either stock or "marketable obligations." A marketable obligation generally is a bond, debenture, or other certificate of indebtedness acquired on the market or from an underwriter or the employer issuing the obligation, so long as:
• the plan does not invest more than 25% of its assets in obligations of the employer or an affiliate;
• the plan holds no more than 25% of the aggregate amount of obligations issued in such issue; and
• at least 50% of the aggregate amount of obligations issued is held by persons independent of the employer issuing the obligation. 129
/Footnote/ 129 ERISA §407(e).
Qualifying employer real property is real property (and related personal property) which is leased to an employer whose employees are covered by the plan or to an affiliate of such an employer if:
• several parcels of real property are leased;
• a substantial number of the parcels are dispersed geographically;
• each parcel (and improvements thereon) is suitable for more than one use (or is so adaptable without excessive cost); and
• the acquisition and continued holding of the parcels is not itself a breach of fiduciary duty (for example, the investment must be prudent). 130
/Footnote/ 130 ERISA §407(d)(4). See, e.g., Zabolotny v. U.S., 97 T.C. 385 (1991), aff'd in part and rev'd in part, 7 F.3d 774 (8th Cir. 1993), nonacq., 1994-22 I.R.B. 4.
An employer that wishes to lease a single parcel of real property to a plan (which would not constitute qualifying real property due to the requirement that such property consist of several geographically dispersed parcels) may be able to obtain an individual exemption from the Department of Labor allowing the transaction. 131
/Footnote/ 131 See the discussion of individual exemptions below.
g. Conversion of Securities
A plan may convert securities issued by a party in interest or disqualified person (such as the sponsoring employer) to the extent provided in the regulations, so long as the plan receives no less than adequate consideration pursuant to the conversion. 132
/Footnote/ 132 ERISA §408(b)(7); Code §4975(d)(7). This exemption should apply without regard to the rules governing a plan's acquisition or sale of qualifying employer securities. ERISA §408(e); DOL Regs. §2550.408(e).
h. Receipt by a Fiduciary or Disqualified Person of Reasonable Compensation
A fiduciary or disqualified person (for example, a plan administrator) may receive reasonable compensation for services rendered, or for reimbursement of expenses properly and actually incurred, in the performance of his or her duties with a plan. No such person who already receives full-time pay from an employer or from an employee association (e.g., a union) whose members are plan participants, however, may receive compensation from the plan for services to the plan, except for reimbursement of expenses properly and actually incurred. 133
/Footnote/ 133 ERISA §408(c)(2); Code §4975(d)(10).
i. Distribution of Plan Assets
A fiduciary may distribute assets from a plan in accordance with its terms if the assets are distributed and allocated among the participants and beneficiaries as provided in ERISA. 134 This exemption allows an employer to recover surplus assets upon termination of an overfunded defined benefit plan, if the plan so provides.
/Footnote/ 134 ERISA §408(b)(9); Code §4975(d)(12). See ERISA §4044 regarding the required allocation.
j. Purchases of Insurance Contracts
If the employer sponsoring a plan is an insurance company, the plan may purchase life insurance, annuity, and health insurance contracts from the insurance company if no more than adequate consideration is paid. 135 It is not necessary to purchase a competitor's products in such a case. The exemption also applies if the insurance company is a party in interest or disqualified person which is wholly owned (directly or indirectly) by the sponsoring employer or by a person which is a party in interest or disqualified person with respect to the plan, if the premiums on insurance written by such company do not exceed, for any year, 5% of the total premiums for all lines of insurance written for the year.
/Footnote/ 135 ERISA §408(b)(5); Code §4975(d)(5).
k. Bank Deposits When Bank is Sponsor or Fiduciary
If a bank or similar financial institution supervised by the federal or a state government is a fiduciary of a plan, it is not a prohibited transaction for the plan to invest all or part of its assets in deposits of the bank or other institution bearing a reasonable interest rate if (1) the plan only covers employees of such bank or institution or its affiliates; or (2) investment is expressly authorized by plan provision or by a fiduciary (other than such a bank or institution or affiliate thereof) whom the plan expressly empowers to so instruct the fiduciary. It is not necessary for the bank or institution to deposit the plan's funds with a competing bank in such a case. 136
/Footnote/ 136 ERISA §408(b)(4); Code §4975(d)(4).
l. Ancillary Bank Services
A bank or similar financial institution supervised by the federal or state government and which acts as a fiduciary for a plan may provide "ancillary services" to the plan if:
• the bank or institution has adopted adequate internal safeguards that assure that providing of such services is consistent with sound banking and financial practice (as determined by federal or state supervisors); and
• the extent to which such services are provided is subject to specific guidelines issued by the bank or institution and such guidelines preclude the bank or institution from providing the services in an excessive or unreasonable manner or in a manner inconsistent with the best interests of participants and beneficiaries of employee benefit plans. In no event can the ancillary services be provided at more than reasonable compensation. 137
/Footnote/ 137 ERISA §408(b)(6); Code §4975(d)(6).
m. Party in Interest Common Trust Fund
Even though maintained by a party in interest or disqualified person, a common or collective trust fund or pooled investment fund maintained by a bank or trust company supervised by a federal or state agency or a pooled investment fund of an insurance company qualified to do business in a state may engage in certain transactions with a plan. The plan may purchase or sell an interest in the fund so long as the bank, trust company, or insurance company receives no more than reasonable compensation and so long as the transaction is expressly permitted by the plan document or by a fiduciary (other than the bank, trust company, or insurance company) that has authority to manage and control the plan's assets (i.e., a trustee or investment manager). 138
/Footnote/ 138 ERISA §408(b)(8); Code §4975(d)(8). See, e.g., DOL Adv. Op. 2005-09A (In-kind exchange of securities owned by a plan or fund holding plan assets for units or interests in a collective investment fund maintained by a bank or trust company is permissible as long as the conditions of ERISA §408(b)(8) are met; whether conditions are met is a decision for the appropriate plan fiduciaries).
n. Transactions with Owner-Employees
The above statutory exemptions are unavailable for certain persons. ERISA and the Code prohibit any transaction, even if otherwise covered by a statutory exemption, in which a plan, directly or indirectly:
• lends any part of the assets or income of the plan to;
• pays any compensation for personal services rendered to the plan to; or
• acquires for the plan any property from or sells any property to;
any person who, with respect to the plan, is one of the following:
• an owner-employee (see below),
• a family member 139 of an owner-employee, or
• a corporation in which the owner-employee owns (directly or indirectly) 50% or more of the total combined voting power of all classes of stock entitled to vote or 50% or more of the total value of shares of all classes of stock of the corporation. 140
/Footnote/ 139 As defined in Code §267(c)(4).
/Footnote/ 140 Code §4975(f)(6) and ERISA §408(d), as amended by P.L. 105-34, §1506.
An owner-employee is an individual who either owns the entire interest in a sole proprietorship or who has a 10% or greater interest as a partner in a partnership (in terms of capital or profits). 141 Generally, for purposes of this rule, an owner-employee also includes a shareholder-employee of an S corporation (an owner of 5% or more of the corporation's stock), the owner of an individual retirement account or individual retirement annuity, and an employer or employee association that establishes a group IRA. 142 However, the sale of employer securities to an ESOP by a shareholder-employee of an S corporation, a member of the family of such shareholder-employee, or a corporation in which such a shareholder-employee owns stock representing a 50% or greater interest, is not a prohibited transaction. 143 For this purpose, a shareholder-employee of an S corporation is an employee or officer owning more than 5% of the outstanding stock of the corporation on any day during the corporation's taxable year. 144
/Footnote/ 141 Code §401(c)(3) (Referenced by §4975(f)(6)(A) and ERISA §408(d)(1), as amended by P.L. 105-34, §1506).
/Footnote/ 142 Code §4975(f)(6)(B)(i) and ERISA §408(d)(2)(A), as amended by P.L. 105-34, §1506.
/Footnote/ 143 Code §4975(f)(6)(B)(ii) and ERISA §408(d)(2)(B), as amended by P.L. 105-34, §1506.
/Footnote/ 144 Code §4975(f)(6)(C) and ERISA §408(d)(3), as amended by P.L. 105-34, §1506. The family stock ownership attribution rules of Code §318(a) apply.
Note: Beginning in 2002, the special rules relating to plan loans to S corporation shareholders, partners and sole proprietors were repealed, thus allowing such plan loans under the general statutory exemptions. The prohibited transaction rules remain in effect with respect to IRAs. 145
/Footnote/ 145 P.L. 107-16, §612, amending Code §4975(f)(6)(B) and ERISA §408(d)(2).
o. Sales of Bank Stock Held by IRA in Connection with S Corporation Election
A statutory exception from the prohibited transaction rules is provided for sales by an IRA to an IRA beneficiary of bank stock held by the IRA. The exemption applies to such a sale if: (1) the sale is pursuant to an S corporation election by the bank; (2) the sale is for fair market value and is on terms at least as favorable to the IRA as the terms would be on a sale to an unrelated party; (3) the IRA incurs no commissions, costs or other expenses in connection with the sale; and (4) the stock is sold in a single transaction for cash no later than 120 days after the S corporation election is made. 145.1
/Footnote/ 145.1 Code §4975(d)(16), added by the American Jobs Creation Act of 2004 (AJCA), P.L. 108-357, §233(c), effective Oct. 22, 2004.
2. Administrative Exemptions
In addition to the statutory exemptions, ERISA grants some flexibility to the federal agencies in applying the prohibited transaction provisions. "Class" exemptions have been promulgated which shield any person from the prohibited transaction rules with respect to certain acts if the facts of that person's situation correspond to the criteria set forth in the class prohibited transaction exemption. Further, the Labor Department issues "individual" exemptions to persons who make a showing that the prohibited transaction rules should not apply to their particular fact settings.
Class and individual exemptions do not protect plan fiduciaries from the consequences of their actions under other provisions of ERISA and the Code; only the prohibited transaction provisions are waived. In particular, the general fiduciary standards continue to apply. Hence a plan investment might be permitted by an exemption despite the fact that without the exemption, a prohibited purchase from the sponsoring employer would occur, but the fiduciary may be personally liable for losses caused to the plan if the investment was not prudent or the investment meant the plan's assets were not sufficiently diversified.
Whether an exemption is for a class of persons or for an individual applicant, ERISA authorizes an administrative exemption only where the federal agency (IRS or DOL) finds that the exemption is:
• administratively feasible;
• in the interests of participants and beneficiaries; and
• protective of the rights of participants and beneficiaries.
Before an exemption is granted, the agency must publish the proposed exemption in the Federal Register for the purpose of soliciting public comments. 146 In general, individual exemptions for consummated transactions are more difficult to obtain, and the applicant runs a risk that the application will be denied (thus alerting the authorities to the situation) or will be approved prospectively only. 147
/Footnote/ 146 Procedures for exemption applications are provided in ERISA Procedure 75-1, 40 Fed. Reg. 18471 and Rev. Proc. 75-26, 1975-2 C.B. 722.
/Footnote/ 147 See DOL Technical Release No. 85-1 (Jan. 22, 1985) for the Department of Labor's policy regarding retroactive exemptions, reproduced at 12 BNA Pension Reporter 166.
An exemption application must include, among other things, the following information:
• a detailed description of the transaction and the party in interest for whom an exemption is requested;
• a description of the possible violations of the prohibited transaction rules involved in the transaction;
• the reasons a plan would have for engaging in the transaction;
• whether the transaction is customary for the industry or class involved;
• the hardship or economic loss to the plan, and to its participants and beneficiaries that would result if the application were denied;
• an explanation of why the exemption would satisfy the three requirements of ERISA §408(a) set forth above;
• the identity of all interested persons and how the applicant proposes to notify them; and
• if the applicant wishes, a draft version of the proposed exemption. 148
/Footnote/ 148 DOL Regs. §2570.34.
Most exemptions are issued by the Department of Labor, even though exemptions apply for purposes of both the labor provisions of ERISA and the Code's excise tax provisions. IRS and DOL continue to have concurrent jurisdiction with respect to a few exemption issues, such as loans to an ESOP. 149
/Footnote/ 149 See ERISA Reorganization Plan No. 4 of 1978, 43 Fed. Reg. 47713 (1978).
a. Class Exemptions
Class exemptions often provide relief for otherwise prohibited transactions. They operate in much the same way as the statutory exemptions. For example, one class exemption allows certain plan service-providers (such as consultants) to sell products to the plan. 150 An insurance company providing administrative services can sell insurance to the plan as an investment if the requirements of the exemption are met (in general, the plan's fiduciaries must approve the commissions to be paid).
/Footnote/ 150 PTE 77-9, 1977-2 C.B. 428, as corrected at 42 Fed. Reg. 33819 (7/1/77), amended and redesignated as PTE 84-24, 49 Fed. Reg. 13208 (4/3/84), as corrected at 49 Fed. Reg. 24819 (6/15/84).
Another insurance-related class exemption allows a participant to purchase from the plan a policy on the participant's life. This otherwise would be a prohibited sale between the plan and a party in interest. 151
/Footnote/ 151 PTE 77-7, 1977-2 C.B. 423 (Purchase by a plan of a contract from a participant or employer), amended and redesignated as PTE 92-5, 57 Fed. Reg. 5019 (2/11/92) (Coverage expanded to include transactions with owner-employees and shareholder-employees); PTE 77-8, 1977-2 C.B. 425 (Sale by the plan of a contract to a participant or employer), amended by PTE 92-6, 57 Fed. Reg. 5189 (2/12/92).
PTE 92-6 151.1 permits the sale of an individual life insurance or annuity contract by an employee benefit plan to a participant under such plan; a relative of a participant under such plan; an employer, any of whose employees are covered by the plan; or another employee benefit plan, if certain conditions are met. The exemption also includes the sale by an employee benefit plan of an individual life insurance or annuity contract to a personal corporate trust established by or for the benefit of an individual who is a participant in the plan and the insured under policy, for by or for the benefit of one or more relatives. 151.2
/Footnote/ 151.1 57 Fed. Reg. 5189 (2/12/92); see also DOL Adv. Op. 98-07A.
/Footnote/ 151.2 67 Fed. Reg. 56313 (9/3/02), amending PTE 92-6.
The lending of securities by plans to banks and broker-dealers that are parties in interest also is exempt under certain conditions. 151.3 Because the loans only can be made to U.S. entities, the DOL proposed amending the exemption to include loans made to non-U.S. entities as well. 151.4 The proposal also would amend PTE 82-63, 151.5 which exempts certain compensation arrangements for the provision of securities lending services by a plan fiduciary to a plan. 151.6
/Footnote/ 151.3 PTE 81-6, 46 Fed. Reg. 7526 (1/23/81), as amended by PTE 2002-13, 67 Fed. Reg. 9483 (3/1/02).
/Footnote/ 151.4 Application No. D-08295, 68 Fed. Reg. 60715 (10/23/03).
/Footnote/ 151.5 47 Fed. Reg. 14804 (4/6/82), as amended by PTE 2002-13.
/Footnote/ 151.6 Application No. D-10365, 68 Fed. Reg. 60715 (10/23/03).
Another class exemption 151.7 permits the issuance of commitments by one or more employee benefit plans for the provisions of residential mortgage financing. Furthermore, PTE 83-1 151.8 permits transactions involving the origination, maintenance and termination of mortgage pools and acquisition and holding by plans of mortgage-backed pass-through certificates where the pool sponsor or trustee is a party in interest. The exemption includes pools containing loans secured by second mortgages and forward delivery commitments.
/Footnote/ 151.7 PTE 88-59, 53 Fed. Reg. 24811 (6/30/99), as amended by PTE 2002-13.
/Footnote/ 151.8 48 Fed. Reg. 895 (1/7/83), as amended by PTE 2002-13.
PTE 81-8 152 permits plans to make investments in short-term money market instruments issued by parties in interest to plans if the party in interest does not make the investment decision, and PTE 97-41 152.1 allows the transfer of benefit funds from bank collective investment funds to bank-affiliated, no-load mutual funds. This eliminates the expense of seeking individual exemptions. Relief also is provided for certain nonbank plan advisers. Thus, PTE 97-41 applies to banks, nonbank advisers, and trust companies acting as fiduciaries of plans investing in collective investment funds maintained by such entities.
/Footnote/ 152 46 Fed. Reg. 7511 (1/23/81), amended by 50 Fed. Reg. 14043 (4/9/85), and PTE 2002-13.
/Footnote/ 152.1 62 Fed. Reg. 42830 (8/8/97).
A class exemption for qualified professional asset managers (QPAMs), such as a bank with at least $1,000,000 in equity capital, allows a collective investment fund managed by such a bank to engage in sales or leases with persons who are parties in interest with respect to a plan participating in the fund. 152.2 The bank must have the exclusive power to negotiate and make investments and the plan to whom the party in interest is related can have no more than 20% of the value of the total client assets being managed by the bank. A similar class exemption applies to banks or trust companies maintaining collective investment funds in which no plan has more than 5% of its total assets in the fund. 152.3
/Footnote/ 152.2 PTE 84-14, 49 Fed. Reg. 9494 (3/10/84), as corrected by DOL Technical Correction No. 197, 50 Fed. Reg. 41430 (10/10/85), and as amended by PTE 2002-13 and by 70 Fed. Reg. 49305 (8/23/05). Other entities eligible for the exemption are savings and loan associations, insurance companies, and registered investment advisers, if certain capital requirements are met. Note that, under the current exemption, employers in the financial services industry are not eligible to serve as QPAMs for their own plans. In Application No. D-11270, 70 Fed. Reg. 49312 (8/23/05), the DOL proposed to amend PTE 84-14 to allow a QPAM to prospectively manage an investment fund containing the assets of its or an affiliate's plan, provided certain conditions are met. Concurrently, in the amendment to the exemption, the DOL provided limited retroactive and transitional relief permitting such managers to meet the requirements for being a QPAM despite their failure to qualify as independent fiduciaries.
/Footnote/ 152.3 PTE 80-51, 45 Fed. Reg. 49709 (7/25/80). See also PTE 78-19, 43 Fed. Reg. 59915 (12/22/78), amended and redesignated as PTE 90-1, 55 Fed. Reg. 2891 (1/29/90); PTE 95-60, 60 Fed. Reg. 33925 (7/12/95), as amended by PTE 2002-13.
The Labor Department also has granted a class exemption for certain plan asset transactions involving an in-house asset manager (INHAM). 153 For this purpose, an INHAM as an organization that is:
• either a direct or indirect wholly owned subsidiary of an employer (or of a parent organization of the employer), or a membership nonprofit corporation a majority of whose members or officers are directors of the employer or a parent organization; and
• an investment advisor registered under the Investment Advisors Act of 1940 that has under its management and control assets attributable to plans made by affiliates of the INHAM in excess of $50 million.
/Footnote/ 153 PTE 96-23, 61 Fed. Reg. 15975 (4/10/96).
Also, plans maintained by the INHAM or its affiliates must have, as of the last day of each plan's reporting year, total assets of at least $250 million. The exemption provides a separate definition of the term "affiliate" with respect to an INHAM and a separate rule concerning whether an INHAM is "related" to a party in interest for purposes of the exemption. 153.1
/Footnote/ 153.1 PTE 96-23.
PTE 86-128 153.2 permits broker-dealers (or their affiliates) who serve as fiduciaries for employee benefit plans to exercise discretionary authority to effect or execute securities brokerage transactions on behalf of their plan clients. The exemption also permits a discretionary trustee of an ERISA-covered plan, or an affiliate of such trustee, to use its fiduciary authority to cause the plan to pay a fee to such trustee for effectuating or executing securities transactions as agent for the plan. 153.3
/Footnote/ 153.2 51 Fed. Reg. 41686 (11/18/86).
/Footnote/ 153.3 67 Fed. Reg. 64137 (10/17/02), amending PTE 86-128.
In addition, PTE 2002-12 153.4 grants a class exemption from certain prohibited restrictions of ERISA, the Federal Employees' Retirement System Act (FERSA), and from the Code's excise tax provisions to permit cross-trades of securities among index and model-driven funds managed by investment managers, and among such funds and certain large accounts that engage such managers to carry out a specific portfolio restructuring program or to otherwise act as a "trading adviser" for such a program. The exemption applies to employee benefit plans whose assets are invested in index or model-driving funds, large pension plans with at least $50 million in total assets, and other large accounts involved in portfolio restructuring programs, as well as the funds and their investment managers.
/Footnote/ 153.4 67 Fed. Reg. 6613 (2/12/02).
PTE 93-1 153.5 specifically applies to IRAs and Keogh plans and supplies an exemption for marketing inducement used to sell such plans. PTE 93-33 153.6 permits banks to supply reduced or no-cost services to IRA and Keogh plan participants or their families based on such plan deposits. Furthermore, PTE 97-11 153.7 permits the receipt of services at reduced or no cost by an individual for whose benefit an IRA or a Keogh plan is established or maintained, or by members of his or her family, from a broker-dealer, provided that certain conditions are met.
/Footnote/ 153.5 58 Fed. Reg. 3567 (1/11/93).
/Footnote/ 153.6 58 Fed. Reg. 31053 (5/28/93), as amended by 64 Fed. Reg. 11044 (3/8/99).
/Footnote/ 153.7 62 Fed. Reg. 5855 (2/7/97), as amended by 64 Fed. Reg. 11042 (3/8/99) and 67 Fed. Reg. 76425 (12/12/02).
A class exemption was granted for certain prohibited transactions under the Code in conjunction with the DOL's Voluntary Fiduciary Correction (VFC) Program. 154 The exemption provides relief for the following prohibited transactions:
• failure to transmit participant contributions to a pension plan within the required timeframes;
• a loan by a plan at a fair market value interest rate to a party in interest with respect to the plan;
• purchase or sale of an asset (including real property) between a plan and a party in interest at fair market value; and
• sale of real property to a plan by the employer and the leaseback of such property to the employer, at fair market value and fair rental value, respectively. 154.1
/Footnote/ 154 PTE 2002-51, 67 Fed. Reg. 70623 (11/25/02). The IRS announced that it would not seek to impose the Code's excise taxes under §4975 with respect to any of the four prohibited transactions covered by the proposed exemption during the pendency of the proposed exemption, so long as a fiduciary satisfied all of the requirements of the proposed exemption. Announcement 2002-31, 2002-15 I.R.B. 747. The VFC program is discussed at ¶5530.07, below.
/Footnote/ 154.1 See §4975(c)(1)(A) through 4975(c)(1)(E). The §4975 excise tax is discussed at ¶5530.03.D, below.
In conjunction with its amendment of the VFC Program, the Labor Department proposed to amend this class exemption to provide relief for the purchase of an illiquid asset by a plan from a party in interest at no greater than fair market value, or the later sale of an illiquid asset to a party in interest as long as the plan receives the correction amount described in the amended VFC Program. 154.2
/Footnote/ 154.2 Application No. D-11261, 70 Fed. Reg. 17476 (4/6/05).
A class exemption permits the acquisition, holding or sale of publicly traded shares of beneficial interest in a real estate investment trust (REIT), that is structured under state law as a business trust (Trust REIT), by individual account plans sponsored by the REIT or its affiliates. 155 The exemption affects participants and beneficiaries of employee benefit plans involved in such transactions, as well as the REITS and their affiliates that sponsor such plans.
/Footnote/ 155 PTE 2004-07, 69 Fed. Reg. 23220 (4/28/04).
Litigation settlements with parties in interest also are exempted if certain conditions are satisfied. PTE 2003-39 155.1 exempts pension plan fiduciaries that reach settlements of litigation with parties in interest in exchange for consideration through other forms. The exemption applies retroactively to January 1, 1975. Relief is provided for:
• the release by the plan of a legal or equitable claim against a party in interest in exchange for consideration in partial or complete settlement of the litigation; and
• an extension of credit by a plan to a party in interest in connection with the settlement to repay, in installments, amounts owed to the plan.
/Footnote/ 155.1 68 Fed. Reg. 75632 (12/31/03).
A genuine controversy involving the plan must exist unless the litigation has been certified as a class action and the terms of both the settlement and extension of credit must be reasonable. The exemption does not apply to transactions relating to delinquent employer contributions to collectively bargained multiemployer or multiple employer plans.
b. Individual Exemptions
Upon application, the Labor Department will consider making an exemption from the prohibited transaction rules for a particular individual or firm with respect to a given transaction. As with class exemptions, an individual exemption is granted only if the DOL finds that the exemption would be administratively feasible, in the interests of participants and beneficiaries, and protective of the rights of participants and beneficiaries. Although hundreds of such exemptions are issued each year, they are far from automatic and can require substantial processing time.
Certain patterns have emerged. Exemptions tend to be granted with respect to two types of transactions:
• those of a continuing nature between a plan and a party in interest; and
• contributions of property.
Examples of continuing transactions are leases or loans, such as an installment sale of property to a plan from an employer. DOL requires a showing of independent safeguards before granting such exemptions, generally including:
an independent fiduciary to determine that the transaction is favorable for the plan; 156
• independent appraisals, if property is involved;
• proper documentation and recording of the transaction;
• guaranty of other parties in interest (such as the owner of a corporate employer) to back up the continued making of any installment payments to the plan;
• insurance for the plan; and
• the transaction should involve a relatively small portion of the total plan assets.
/Footnote/ 156 The transaction cannot be too favorable; a bargain sale by an employer to a plan will be considered in part a contribution by the employer, which could cause the plan to become disqualified due to the Code's limits on annual additions/benefits (see Code §415). Such a result would not be in the interest of the participants and beneficiaries. See Preamble, PTE 80-26, 45 Fed. Reg. 28545 (4/6/80) at 28546, n.6.
An example of a contribution of property by an employer or other party in interest to a plan is a contribution of encumbered property when the plan assumes the mortgage or when the mortgage had been placed on the property by a party in interest within the 10-year period ending on the date of the transfer. 157 DOL may even view a contribution that appears to have no strings attached as a prohibited "exchange" between the party in interest and the plan that requires an individual exemption. 158 For example, the Code's minimum funding requirements apply to an employer sponsoring a defined benefit or money purchase plan. If such employer makes its annual contribution to the plan partially or completely in property rather than cash, DOL would find that the property has been exchanged in partial or complete satisfaction of the employer's funding obligation. Before granting an exemption for contributions of property, DOL likely will require a showing of:
• an evaluation of the contribution by an independent fiduciary;
• the future marketability of the property (whether the plan will be able to readily dispose of it);
• the portion of the total plan assets which the contributed property will constitute; and
• the reasons the contribution of property is preferable to one in cash.
/Footnote/ 157 ERISA §406(c); Code §4975(f)(3).
/Footnote/ 158 Code §4975(c)(1)(A); ERISA §406(a)(1)(A). See DOL Advisory Opinion 81-69A (Contribution to defined benefit plan of option to purchase real property); see generally, Preamble, DOL Regs. §2550.408(e), 45 Fed. Reg. 51194 (8/1/80) at 51195-96, nn. 8-11.
DOL has ruled that no exchange occurs when the contribution of property is "purely voluntary," such as where a contribution is made to a profit-sharing plan (a plan which is exempt from the minimum funding standards) and the employer is under no obligation under the plan to make a contribution. 159
/Footnote/ 159 PWBP Opinion Letter (3/8/85) (Contribution of unencumbered real property).
c. Expedited Process for PTEs
Partially in response to public criticism that the prohibited transaction process was too drawn out for the pace of modern business, i.e., often by the time an approval is secured, the business opportunity to enter into a transaction has been lost or greatly diminished, the Labor Department developed an expedited process for plans to receive prohibited transaction exemptions. 160 Under this process, an exemption applicant must either: (1) identify at least two substantially similar individual exemptions granted by the DOL within the last five years, describe the transaction and provide a comparison of the proposed transaction with the two previous ones; or (2) identify one individual exemption granted by the DOL within the last 120 months that provided relief from the same transaction and one authorized transaction (i.e., a transaction that received final authorization by the DOL under this expedited process guidance within the last 60 months). In addition, the applicant must engage an independent fiduciary to review and monitor the proposed transaction. Forty-five days after the application is submitted (and acknowledged by DOL), it will be considered to have been tentatively approved unless DOL objects to the submission. In that case, the applicant must notify all interested persons of their right to comment. The comment period extends for 25 days. Five days after the comment period expires, the approval is considered final if no negative comments are offered. Thus, it is possible for an applicant to obtain a full individual exemption within less than a three-month period. The expedited process, however, is not available for situations that are somewhat unique, i.e., those for which two substantially similar prior exemptions do not exist.
/Footnote/ 160 PTE 96-62, 61 Fed. Reg. 39988 (7/31/96), as amended by PTE 2002-13, 67 Fed. Reg. 9483 (3/1/02), and by 67 Fed. Reg. 44622 (7/3/02).

Colin M. Cody, CPA, CMA
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