ERISA Prohibited Transactions and Party-in-Interest Rules

ERISA prohibited transactions are financial dealings between a private-sector benefit plan and anyone closely connected to it that the statute bans outright, regardless of whether the terms look fair. The law treats these deals as inherently risky because the people nearest the plan’s assets have the most opportunity to exploit them. A violation is a per se violation: fair pricing, arm’s-length negotiation, and even a net benefit to the plan do not save it. The consequences layer excise taxes, civil penalties, personal liability, and reporting obligations on top of one another by design, so no single penalty gets treated as a cost of doing business.

Who Counts as a Party in Interest

ERISA Section 3(14) defines “party in interest” broadly, and the designation is about proximity to plan money rather than intent.¹ The core categories are:

Fiduciaries — trustees, investment managers, plan administrators, and anyone else with discretionary control over the plan or its assets.
Service providers to the plan — attorneys, accountants, actuaries, third-party administrators, recordkeepers, and similar vendors.
Sponsoring employers whose employees participate in the plan.
Employee organizations, such as unions, whose members are covered.
Anyone holding 50 percent or more of the voting stock, capital interest, or beneficial interest in the sponsoring employer or employee organization.

The reach extends into the ranks of connected organizations. Officers, directors, and people with similar authority at a service provider, sponsoring employer, employee organization, or majority owner all qualify, as do 10-percent-or-greater shareholders of those entities.¹ A director of a company that provides recordkeeping to a pension fund is a party in interest to that fund, even without ever touching the plan.

Relatives

ERISA Section 3(15) defines “relative” as a spouse, ancestor, lineal descendant, or the spouse of a lineal descendant.² If you serve as a plan trustee, that means your spouse, parents, children, grandchildren, and your children’s spouses. Siblings, aunts, uncles, and cousins are not covered. The line is narrower than many people expect, but the family members who are covered often catch fiduciaries off guard when a family loan or real estate deal suddenly falls inside the rules.

Entities Controlled by Parties in Interest

Any corporation, partnership, trust, or estate in which parties in interest collectively own 50 percent or more of the equity is itself a party in interest.¹ The obvious workaround — routing a deal through a shell entity — doesn’t work. If a plan trustee and the sponsoring employer’s CEO together own 60 percent of a real estate LLC, that LLC cannot do business with the plan.

The Transactions ERISA Bans

Section 406(a) lists specific transaction types that are flatly prohibited between a plan and any party in interest, directly or indirectly:

Sales, exchanges, or leases of property. A sponsoring employer cannot sell a building to its own pension fund, even at a steep discount.³
Loans or extensions of credit in either direction between the plan and the party in interest.
Providing goods, services, or facilities between the plan and the party in interest, outside the specific exemption for necessary services at reasonable compensation.
Transferring plan assets to, or using them for the benefit of, a party in interest. Indirect benefit counts.
Acquiring employer securities or employer real property beyond permitted limits.³

The “direct or indirect” language is where many violations hide. A deal structured through intermediaries to disguise a party-in-interest connection isn’t cleaned up by the routing. The law reaches indirect transactions just as thoroughly as direct ones.

Fiduciary Self-Dealing

Section 406(b) targets the fiduciary’s own conflicts, and it applies even when no party in interest sits on the other side. Three prohibitions attach to every fiduciary:

Using plan assets for the fiduciary’s own interest or benefit. An investment advisor directing plan funds into a company they personally own is the textbook example.³
Acting on behalf of a party whose interests are adverse to the plan. You can’t negotiate a deal for the plan while also representing the counterparty.
Receiving any payment from a third party in connection with a plan transaction. An advisor who accepts a commission for steering plan deposits to a particular financial institution has violated this rule, whether or not the plan got a competitive rate.

These violations don’t require proof that the plan lost money. The conflict is the harm the law targets. A fiduciary who pockets a $500 referral fee on a transaction that saved the plan $50,000 has still committed a prohibited transaction.

Exemptions That Make Plan Operations Possible

A plan that couldn’t hire a lawyer, pay a recordkeeper, or let participants borrow from their accounts would be unworkable. ERISA Section 408 carves out categories of transactions that are permitted despite technically falling within the prohibited list.⁴

Necessary Services at Reasonable Compensation

A plan can contract with a party in interest for services necessary to the plan’s operation — legal, accounting, recordkeeping, investment management — as long as the compensation is reasonable and no more than the plan would pay on the open market.⁴ This is the exemption that keeps the plan administration industry running. Overpaying a service provider who is also a party in interest turns an exempt arrangement back into a prohibited one, and that’s where DOL investigators focus.

Participant Loans

Plans can lend money to participants when the loans are available on a reasonably equivalent basis to all participants and beneficiaries, are not disproportionately available to highly compensated employees, follow the plan’s written loan provisions, carry a reasonable interest rate, and are adequately secured.⁴ The tax code adds dollar limits: the loan cannot exceed the lesser of $50,000 (reduced by certain outstanding balances from the prior year) or 50 percent of the participant’s vested account balance.⁵ A loan that violates any of these conditions doesn’t qualify and becomes a prohibited transaction.

De Minimis Enrollment Incentives

The SECURE 2.0 Act added a narrow exemption for employers offering small financial incentives to encourage 401(k) or 403(b) enrollment. A modest gift card to nudge participation had technically been a prohibited transaction; the new rule exempts de minimis incentives from both the excise tax under the tax code and the ERISA prohibited transaction rules.⁶

DOL Individual and Class Exemptions

Beyond the safe harbors written into ERISA, the Department of Labor can grant additional exemptions. A plan or party in interest can apply to the DOL’s Office of Exemption Determinations for permission to complete a specific transaction. The Department will only grant it after finding the transaction is administratively feasible, in the interests of the plan and its participants, and protective of participants’ rights.⁷ Because the process is slow and expensive, individual exemptions are pursued only when the stakes justify it.

Class exemptions apply broadly across the industry. PTE 84-14 permits various party-in-interest transactions when plan assets are managed by a qualified professional asset manager meeting specified independence and financial standards. PTE 2020-02 permits investment advice fiduciaries to receive compensation resulting from their advice, including advice to roll over assets from a plan to an IRA, provided they meet specific disclosure and conduct requirements. Each class exemption has its own conditions, and failing any one of them strips the protection entirely.

Employer Stock and Real Property Limits

ERISA Section 407 restricts how much of a plan’s portfolio can consist of the sponsoring employer’s stock or real estate. A plan generally cannot acquire employer securities or employer real property if doing so would push those holdings above 10 percent of plan assets.⁸ A fiduciary who lets the plan cross that line has caused a prohibited transaction under Section 406(a)(1)(E).

Individual account plans — 401(k)s, profit-sharing plans, and ESOPs — are generally exempt from the 10 percent ceiling.⁸ That’s why ESOPs can hold mostly employer stock and why some 401(k) plans offer company stock as an investment option. Even within that exemption, fiduciaries still owe a duty of prudence.

What a Violation Costs

The penalty regime hits from multiple directions at once.

The Two-Tier Excise Tax

IRC Section 4975 imposes an excise tax on any “disqualified person” — the tax code’s parallel term for party in interest, with substantially overlapping but not identical definitions — who participates in a prohibited transaction. The first-tier tax is 15 percent of the “amount involved” for each year or partial year the transaction remains uncorrected.⁹ If the violation isn’t fixed within the taxable period, the second-tier tax jumps to 100 percent of the amount involved.

The “amount involved” is the greater of the money or fair market value given versus received. For service-related violations, only the excess compensation counts.¹⁰ For the first-tier tax, fair market value is measured on the date the transaction occurred. For the second-tier tax, it’s the highest value during the entire taxable period, so a transaction involving appreciated assets grows more expensive the longer it goes uncorrected.

A fiduciary acting only in their fiduciary capacity is exempt from this excise tax.⁹ A trustee who approves a prohibited transaction in good faith while carrying out plan duties won’t owe the excise tax personally, but the party on the other side of the deal will.

What “Correction” Actually Requires

Correcting a prohibited transaction means undoing it to the extent possible and restoring the plan to the financial position it would have been in had the disqualified person acted under the highest fiduciary standards.⁹ That second part matters. If a plan sold property to a party in interest at fair market value and the property later appreciated, correction means returning the property and compensating the plan for the gain it missed. Reversing the transaction at the original price is not enough.

DOL Civil Penalties

The Department of Labor can assess a civil penalty equal to 20 percent of any amount recovered from a fiduciary or other person through a settlement or court order under ERISA Section 502(l).¹¹ This penalty stacks on top of the excise tax; they are collected by different agencies and serve different purposes.

Section 502(i) allows the DOL to impose a separate penalty of up to 5 percent of the amount involved for each year a prohibited transaction continues. If the transaction isn’t corrected within 90 days after the Secretary provides notice, that penalty can climb to 100 percent of the amount involved.¹²

Personal Liability

Fiduciaries who breach their duties face personal liability for any losses the plan suffers and must restore those losses out of their own assets. Courts can order disgorgement of any profits the fiduciary made from the breach. In severe cases, a court may remove the fiduciary and permanently bar the person from serving any ERISA plan.

Fixing a Violation Before Enforcement

The Department of Labor’s Voluntary Fiduciary Correction Program gives fiduciaries a structured path to fix certain violations before they escalate. The VFCP covers 19 categories of eligible transactions, including late deposits of participant contributions, below-market-rate loans to parties in interest, improper purchases and sales of plan assets, and excess compensation to service providers or fiduciaries.¹³

Correction under the program generally requires restoring the plan to the position it would have been in had the breach never occurred: returning the principal amount involved, paying the greater of lost earnings or profits gained from the use of the money, covering associated expenses like appraisal costs, and making supplemental distributions to affected participants when necessary.¹³

The payoff for completing the process is a no-action letter from EBSA stating that the agency will not bring civil enforcement action against the applicant for the corrected breach and will not impose Section 502(l) or 502(i) penalties on the amounts repaid.¹⁴ The letter has real limits. It binds only EBSA, not the IRS or any other agency. Plan participants remain free to bring their own claims. And if the underlying transaction is a prohibited transaction for which no exemption exists, EBSA will refer the matter to the IRS, which can still impose excise taxes under Section 4975.

Reporting Obligations

A prohibited transaction triggers filings that many plan sponsors overlook until it’s too late.

IRS Form 5330

Any disqualified person who owes the excise tax under Section 4975 must file Form 5330. The deadline is the last day of the seventh month after the end of the tax year of the employer or person responsible for filing. Electronic filing is mandatory for filers required to file at least 10 returns of any type during the calendar year the Form 5330 is due. Late filing carries a penalty of 5 percent of the unpaid tax per month (up to 25 percent), late payment adds another half percent per month (also up to 25 percent), and interest accrues from the original due date.¹⁵

Form 5500 Schedule G

Plans that engaged in nonexempt prohibited transactions during the plan year must report them on Schedule G (Part III) of the annual Form 5500 filing. The schedule requires detailed disclosure: the identity of the party involved, their relationship to the plan, a description of the transaction, purchase and selling prices, transaction expenses, current asset values, and any net gain or loss.¹⁶ Filing Schedule G does not fix the violation or substitute for Form 5330. It is a disclosure obligation on top of everything else, and it puts the DOL on notice that a problem exists.

Time Limits for Bringing Claims

No action for a fiduciary breach or prohibited transaction can be brought after the earlier of six years from the date of the last action constituting the breach, or three years from the date the plaintiff first had actual knowledge of the violation.¹⁷ In practice, the three-year clock often controls for participants who discover problems through audits or disclosures.

If the fiduciary concealed the violation or committed fraud, the statute extends to six years from the date the breach was actually discovered.¹⁷ Prohibited transactions are often buried in plan records and don’t surface until a DOL audit or whistleblower complaint triggers a deeper look, which is why the fraud extension matters.

1
Office of the Law Revision Counsel. 29 USC 1002 – Definitions
2
Office of the Law Revision Counsel. 29 US Code 1002 – Definitions
3
Office of the Law Revision Counsel. 29 USC 1106 – Prohibited Transactions
4
Office of the Law Revision Counsel. 29 USC 1108 – Exemptions From Prohibited Transactions
5
Internal Revenue Service. Borrowing Limits for Participants With Multiple Plan Loans
6
Internal Revenue Service. Notice 2024-02 – Miscellaneous Changes Under the SECURE 2.0 Act of 2022
7
Federal Register. Procedures Governing the Filing and Processing of Prohibited Transaction Exemption Applications
8
Office of the Law Revision Counsel. 29 US Code 1107 – Limitation With Respect to Acquisition and Holding of Employer Securities and Employer Real Property
9
Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
10
Legal Information Institute. 26 USC 4975(f)(4) – Amount Involved
11
U.S. Department of Labor. EBSA Enforcement Manual – Civil Penalties
12
Office of the Law Revision Counsel. 29 US Code 1132 – Civil Enforcement
13
U.S. Department of Labor. Fact Sheet – Voluntary Fiduciary Correction Program
14
U.S. Department of Labor. Voluntary Fiduciary Correction Program Sample No-Action Letter
15
Internal Revenue Service. Instructions for Form 5330
16
U.S. Department of Labor. Schedule G (Form 5500) Financial Transaction Schedules
17
Office of the Law Revision Counsel. 29 US Code 1113 – Limitation of Actions