How do you calculate the ERISA 25 per cent plan asset test?

The benefit plan investor test worked on one fund's investor list, with the partial count for feeders, the exclusion that raises the percentage, and the size of the cure.

Julian R. Sterling · from The Private Fund Compliance Officer

The ERISA 25 per cent test divides the value of a class of fund interests held by benefit plan investors by the value of that class, after removing from the denominator every interest held by the manager, the general partner and their affiliates. Benefit plan investors at 25 per cent or more make the fund's assets plan assets. In an illustrative 400 million class, 98.0 million of plan money over a 380 million denominator is 25.79 per cent, a failed test, although the same 98.0 over the full 400 reads 24.50 and looks like a pass.

Worked in full in The Private Fund Compliance Officer by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

The rule

Under the Department of Labor's plan asset regulation, as modified by section 3(42) of ERISA, a private fund that is not an operating company avoids holding plan assets only if participation by benefit plan investors is not significant: under 25 per cent of the value of each class of equity interests, tested immediately after every acquisition of an interest, which in practice means every closing, transfer and redemption. Three definitions do the work.

Benefit plan investors are plans subject to Title I of ERISA, plans subject to section 4975 of the Internal Revenue Code such as IRAs, and entities whose assets are plan assets. Governmental plans, church plans and non-US plans are not benefit plan investors.
A plan-asset entity counts only in part: to the extent of the percentage of its own equity held by benefit plan investors. A feeder or fund of funds under 25 per cent plan-owned does not hold plan assets at all and counts for nothing.
Controlling persons are disregarded: interests held by anyone with discretionary authority over the fund's assets, anyone paid to advise it, and their affiliates, leave the denominator, unless they are themselves benefit plan investors.

The assumptions

A fictional buyout fund with one class of limited partner interests, USD millions, at its final closing.

Investors in the class and what each counts for
Investor	Interest	Counted as plan	Treatment
General partner commitment	6	0.0	Excluded
Manager partners' vehicle (affiliate)	14	0.0	Excluded
Corporate defined benefit plan (ERISA)	60	60.0	In full
Multiemployer plan (ERISA)	20	20.0	In full
Fund of funds, 37.5% held by plans	48	18.0	In part
Third-party wealth feeder, 10% IRA money	80	0.0	Under 25%, not plan assets
State pension plan	90	0.0	Governmental plan
Non-US pension plan	40	0.0	Not subject to ERISA
University endowment	42	0.0	Not a plan
Total	400	98.0

The calculation step by step

Benefit plan percentage = interests held by benefit plan investors / (total interests in the class − interests held by controlling persons and affiliates)

Numerator = 60 + 20 + 48 × 37.5% = 98.0

Denominator = 400 − 6 − 14 = 380

98.0 / 380 = 25.79%: 25 per cent or more, so participation is significant.

Excel, with amounts in B, plan share in C and an exclusion flag in D: =SUMPRODUCT(B2:B10,C2:C10)/(SUM(B2:B10)-SUMIF(D2:D10,"Y",B2:B10))

The fund of funds counts for 18.0 of its 48 because plans own 37.5 per cent of it; it holds plan assets, but only that share is benefit plan money. The wealth feeder is 10 per cent IRA money, below its own 25 per cent line, so it is not a plan-asset entity and counts as zero. The state and non-US pensions, 130 between them, are pension money that the test ignores.

The result: why the exclusion cuts against you

Disregarding the general partner and the affiliate does not help the fund: it shrinks the denominator and raises the percentage. Here it turns 24.50 per cent into 25.79. A compliance file that divides by total commitments shows a pass on a fund that has, in fact, taken on plan assets: the manager becomes an ERISA fiduciary for the fund's investments, the prohibited transaction rules reach the fund's dealings with parties in interest, and the fee and carry arrangements become fiduciary questions.

Two cures are available before the closing. Admit more than 12.0 of non-plan capital, since 98.0 over 392.0 is exactly 25.00 per cent and the rule fails at 25 per cent, not above it. Or cut a plan's allocation by more than 4.0: at 94.0 over 376.0 the fund is again exactly at 25.00. Put the other way, with a 380 denominator, plan money must stay below 95.0.

What if the fund of funds were more plan-heavy?

Benefit plan percentage by the share of the fund of funds held by plans
Plan share of fund of funds	Counted	Numerator	Percentage
0% to 24.9%	0.0	80.0	21.05%
25.0%	12.0	92.0	24.21%
37.5%	18.0	98.0	25.79%
50.0%	24.0	104.0	27.37%
100.0%	48.0	128.0	33.68%

The step at 25 per cent is real: a fund of funds just under its own line counts for nothing, and just over it counts for 12.0. That is why the subscription documents should ask every fund-of-funds and feeder investor for its own benefit plan percentage, and require it to notify changes. The test also reruns on transfers. If the endowment sells 20 of its interest to an ERISA plan, the class reads 118.0 over 380, 31.05 per cent. If it sells the same 20 to the manager's vehicle, the numerator does not move but the denominator does: 98.0 over 360, 27.22 per cent.

Commitments of every investor also feed the adviser's regulatory assets; see how to calculate regulatory AUM for Form ADV.

The common mistakes

Dividing by total commitments. 24.50 per cent instead of 25.79: the pass is an artefact.
Counting a plan-asset feeder in full. The fund of funds at 48 instead of 18.0 gives 33.68 per cent and can refuse capital the fund could have taken.
Counting IRAs inside a feeder under 25 per cent. Adding the 8 gives 27.89 per cent.
Treating every pension as a plan. Counting the state and non-US plans gives 60.00 per cent.
Testing only at the final close. Transfers and redemptions are acquisitions too.

Takeaway

Numerator: ERISA plans, IRAs and the plan share of plan-asset entities. Denominator: the class less the GP, the manager and affiliates.
Here 98.0 / 380 = 25.79 per cent, a failed test, against 24.50 on the naive base.
The cure at this closing is more than 12.0 of non-plan capital or a plan cut-back of more than 4.0.

The testing logic behind a defensible compliance file, and how to evidence it, is in the free workbook and working documents for this book.

Questions readers ask

Who counts as a benefit plan investor for the 25 per cent test?

Plans subject to Title I of ERISA, plans subject to section 4975 of the tax code such as IRAs, and entities holding plan assets, the last only to the extent of their own plan ownership. Governmental, church and non-US plans do not count. In the worked case pension plans of every kind hold 210 of the class, yet only 98.0 counts, including the plan share of a fund of funds.

Why are the general partner's interests excluded from the ERISA test?

The plan asset regulation disregards interests held by persons with discretionary control over the fund's assets or who advise it for a fee, and their affiliates, so that the manager cannot dilute plan investors with its own money. The effect is to shrink the denominator: removing 20 of GP and affiliate interests lifts the ratio from 24.50 to 25.79 per cent.

What happens if a fund fails the ERISA 25 per cent test?

Its assets become plan assets. The manager becomes an ERISA fiduciary over the fund's investments and the prohibited transaction rules apply to its dealings. To avoid it at a closing, the fund admits more non-plan capital or scales back plan commitments: in the worked case more than 12.0 of non-plan money, or a plan cut-back of more than 4.0.

Read the whole case

This article is one calculation from The Private Fund Compliance Officer. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.

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