Use of Qualified 401(a) Non-Electing Church Plan Assets to Indemnify Church Employees/Directors

[Kate Belyayeva]

Would it be a problem under any federal law (e.g., IRC 401(a)(2) Exclusive Benefit Rule, IRC 503 prohibited transaction rules…) for a qualified 401(a) non-electing church plan to add a provision to its plan (and 501(a) trust agreement) to provide for indemnification of the board members and employees who administer the plan against liability (except in the cases of willful or wanton conduct, gross negligence, and gross malfeasance), with such indemnification to be payable from its plan assets. Assume that there are no state law issues to consider (focus is on federal law). Of course, since it’s a non-electing church plan, it is exempt from ERISA. Any specific or general thoughts would be greatly appreciated. Thanks!

[Peter Gulia]

While many paragraphs of Internal Revenue Code § 401(a) don’t apply or apply differently regarding a church plan, § 401(a)(2) is not among those.

Thus, a tax-qualification condition is that “under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of [the employer’s] employees or their beneficiaries[.]”

Some indemnity is proper. For example, an indemnity State law provides a trustee even if nothing is specially expressed in the trust document likely is a fit. And a somewhat broader indemnity might be appropriate, especially if without it the plan might suffer some difficulty in attracting good people willing to serve as the plan’s trustees.

But a too-broad indemnity might invade the exclusive-benefit concept.

To balance those points, one might consider how much indemnity a charitable corporation may provide its director or officer. See, for example, Ala. Code § 10A-3-2.43.

Even if a desired indemnity would be within a respectable range, one might look for whether the provision would be enforceable or void under the governing State law’s trust code or other statutory or common law of trusts. See, for example, Ala. Code §§ 19-3B-105(b)(9), 19-3B-1008.

If it is the to-be-indemnified trustees who have power to make or amend the governing documents, one might consider doing something to show that making the indemnity is not “inserting” an exoneration provision or otherwise self-dealing. Approval by the church might help.

A church plan’s indemnity should not be contrary to the internal law of the church that established the church plan, or regarding which, the church plan is established. This might matter considerably for a hierarchical church, or less so for a convention that favors local church autonomy.

If you want some free help, please feel welcome to call me. I’m experienced with church plans, and I regularly work with Alabama people.