Indirect Compensation: What It Means for Employers

What it means in practice

Two meanings, one term. In everyday HR and pay planning, "direct" compensation is the cash in a paycheck and "indirect" compensation is the rest of the package: insurance, retirement contributions, paid leave and other employee benefits. In employee benefit plan law the phrase has a narrower, defined meaning: money or other value a plan's service provider receives from someone other than the plan or the employer, such as a fee paid by a mutual fund to the plan's recordkeeper. The first meaning is about what employees receive. The second is about what vendors receive, and it carries legal duties for the employer as plan sponsor. This page takes them in turn. For the full picture of pay, see compensation.

Meaning 1: non-wage pay, as BLS measures it. The Bureau of Labor Statistics (BLS) does not use the label "indirect compensation." Its glossary defines compensation as "employer costs for wages, salaries, and employee benefits" and benefits as "nonwage compensation provided to employees by their employer," which is the closest official match. The BLS Handbook of Methods draws the line precisely. Wages and salaries include commissions, production bonuses, piece rates, cost-of-living allowances, hazard pay and pay deferred through a salary reduction plan. Uniform and tool allowances, free or subsidized room and board, tips paid by third parties and on-call pay are not counted as wages. Shift differentials, premium pay for overtime, holidays and weekends, and nonproduction bonuses such as year-end and profit-sharing bonuses are counted as benefits. So a 401(k) deferral an employee elects is still a wage in BLS terms, while the employer's matching contribution is a benefit.

The latest BLS figures. The Employer Costs for Employee Compensation (ECEC) release of September 9, 2026, covering June 2026, groups benefits into paid leave, supplemental pay, insurance, retirement and savings, and legally required benefits. In private industry, benefits averaged $14.07 of $46.89 per hour worked (30.0%). The share depends on who is employed: benefits were $17.03 of $54.00 (31.5%) for full-time private workers but $5.05 of $25.20 (20.0%) for part-time workers, and $25.78 of $66.45 (38.8%) in state and local government. Paid leave cost $4.40 an hour (8.1% of compensation) for full-time workers and $0.90 (3.6%) for part-time workers. The next release, for September 2026 data, is scheduled for December 16, 2026, and BLS says ECEC will remove workers' compensation costs beginning with December 2026 data, so later figures will not be directly comparable.

Which non-wage pay is taxable. For federal tax, the starting rule in Publication 15-B (2026) is that a fringe benefit is taxable unless the law specifically excludes it; the fringe benefits page walks through the exclusions and valuation rules. Publication 15 (2026) adds the payroll treatment of common benefit costs. Employer payments for accident or health insurance are not wages for income tax withholding, Social Security, Medicare or FUTA, except that the value is included for income tax withholding for a more-than-2% S corporation shareholder. Employer contributions to a qualified plan are exempt from all three. Elective 401(k) deferrals are generally exempt from income tax withholding but taxable for Social Security, Medicare and FUTA. Accountable plan expense reimbursements are not wages, and payments in kind, such as goods or lodging, are generally taxable at fair market value unless an exclusion applies. Taxable non-cash items become imputed income.

Example 1 (illustration): a total compensation statement. An employer pays a salary of $60,000 in 2026, $9,000 toward the employee's health premium and a $1,800 match to the employee's 401(k). Indirect compensation in the HR sense is $10,800 plus the employer's legally required payroll taxes, which at 7.65% of $60,000 for Social Security and Medicare add $4,590, for $15,390 in total (20.4% of a $75,390 package). The $9,000 premium and the $1,800 match are not wages under Publication 15. If the employee elects $6,000 of 401(k) deferrals, that $6,000 stays in Social Security and Medicare wages.

Meaning 2: why ERISA defines the term. ERISA section 406(a) generally bars a plan from paying a "party in interest," a group EBSA says includes service providers, for services. Section 408(b)(2) exempts the payment only if the service is necessary for the plan, the contract or arrangement is reasonable, and no more than reasonable compensation is paid (29 CFR 2550.408b-2(a)). Since July 1, 2012, a pension plan's contract with a covered service provider is not "reasonable" unless the provider discloses its fees in writing, including all indirect compensation. EBSA's fact sheet says revenue sharing and similar arrangements had made it hard for sponsors to understand "how, and how much, service providers are compensated."

Key definitions. Under 29 CFR 2550.408b-2(c)(1): a covered plan is an ERISA pension plan, but not a SEP, SIMPLE IRA, IRA or certain pre-2009 403(b) contracts. A covered service provider is one that expects $1,000 or more in compensation for services as an ERISA fiduciary or registered investment adviser; as a recordkeeper or broker for a participant-directed plan that offers designated investment alternatives; or for accounting, auditing, actuarial, banking, consulting, custodial, insurance, legal, recordkeeping, brokerage, third party administration or valuation services when it expects indirect compensation. Direct compensation comes from the plan; indirect compensation comes from anyone other than the plan, the plan sponsor, the provider or its affiliate. The responsible plan fiduciary is the one with authority to enter into, extend or renew the contract.

What the provider must disclose. For indirect compensation, the written disclosure must describe the compensation, identify the services it relates to and the payer, and describe the arrangement under which it is paid. Transaction-based pay among affiliates and subcontractors (commissions, soft dollars, finder's fees) and charges reflected in an investment's value (such as Rule 12b-1 fees) must also be described. A recordkeeper that offsets its fee with other revenue must give a good-faith estimate of the cost of recordkeeping. Disclosures are due reasonably in advance of the contract or renewal; most changes must be disclosed within 60 days, investment information at least annually, and good-faith errors corrected within 30 days of discovery. On written request, the provider must also furnish what the plan needs for its own reporting, such as Schedule C.

Group health plans. The Consolidated Appropriations Act, 2021 added ERISA section 408(b)(2)(B), which applies the same structure to group health plans for contracts entered into, extended or renewed on or after December 27, 2021. It covers brokers and consultants that expect $1,000 or more for services such as insurance product selection, pharmacy benefit management, stop-loss insurance, wellness and third party administration. Indirect compensation expressly includes vendor incentive pay to a brokerage that is not tied solely to the plan's contract. DOL Field Assistance Bulletin 2021-03 says the rule applies to insured and self-insured plans, to small plans exempt from filing Form 5500, and in DOL's view to limited-scope dental and vision plans, and that labels such as "consultant" do not decide coverage. Health plan vendor reviews are part of employee benefits administration.

Schedule C of Form 5500. The 2025 Form 5500 instructions require Schedule C for a large plan (generally 100 or more participants at the start of the plan year) when a service provider received $5,000 or more in direct or indirect compensation. Indirect compensation for Schedule C means compensation received "from sources other than directly from the plan or plan sponsor" in connection with services to the plan. Examples include investment management fees, sub-transfer agency fees, shareholder servicing fees, 12b-1 fees, finder's fees, float revenue and soft dollars; ordinary fund operating expenses such as attorneys' and accountants' fees are not reportable. Only line 1 is needed for "eligible indirect compensation" if the plan received written disclosures of its existence, services, amount or formula, and payer and recipient. Fiduciaries and certain providers must name each source of indirect compensation of $1,000 or more on line 3, and gifts of insubstantial value (under $50 each and under $100 a year from one source) may be excluded. Providers that fail or refuse to supply information go in Part II, and Schedule C is open to public inspection. Form 5500 is due by the last day of the 7th calendar month after the plan year ends.

Why fiduciaries must review it. EBSA's "Meeting Your Fiduciary Responsibilities" (September 2021) says hiring a service provider is itself a fiduciary function, that fees must be "reasonable," and that some providers receive additional fees from investment vehicles such as mutual funds. Its fee guide notes that investment fees are deducted from returns, so they "may not be immediately apparent to employers." Fiduciaries who breach their duties may be personally liable to restore plan losses. If a provider fails to disclose, the regulation gives the fiduciary prohibited transaction relief only if the fiduciary did not know of the failure, requests the information in writing, notifies DOL within 30 days after the earlier of a refusal or 90 days from the request, and then decides whether to end the contract.

Example 2 (illustration): revenue sharing offset. A 401(k) plan holds $2,000,000 in a fund that pays the recordkeeper a 0.25% servicing fee, or $5,000 a year. The recordkeeper charges $12,000 but credits the $5,000. Following the element (d) instruction, Schedule C shows $7,000 of direct compensation, and the $5,000 is indirect compensation. The disclosure lets the fiduciary assess the full $12,000, not just the $7,000 invoice.

Example 3 (illustration): the $5,000 threshold. A large plan's auditor received $6,000 from the plan, and a consultant received $4,000 in direct fees and a $1,500 finder's fee from a fund company. Both crossed $5,000 in total, so both are listed, even though the consultant's invoices alone stayed under it.

Step by step for a plan sponsor. (1) List every provider to each retirement and group health plan. (2) Collect each 408(b)(2) disclosure before signing or renewing. (3) Total direct and indirect compensation per provider and compare it with the services. (4) Log change notices and annual investment updates. (5) Request anything missing in writing and track the 90-day clock. (6) Request Schedule C data well before the Form 5500 deadline.

Where states differ. The federal regulation does not supersede state laws on disclosures by these providers unless they prevent its application (29 CFR 2550.408b-2(c)(1)(x)). One example: New York Insurance Regulation 194 (11 NYCRR 30) requires producers to give a mandatory initial disclosure of their role and compensation, with amounts disclosed if the purchaser asks. The Department of Financial Services FAQ says that for group policies the disclosure always goes to the group policyholder, such as the employer, and that producers keep copies for three years. On the tax side, state income tax treatment of benefits can differ from federal; check the state revenue agency.

Question: Does the 408(b)(2) rule apply to a small 401(k) plan? Yes. The pension rule has no participant threshold; plan size matters for Schedule C, not for the disclosures.

Question: Is a fee the employer pays from its own account indirect compensation? No. Both definitions exclude payments by the plan sponsor, and the Schedule C instructions say sponsor payments not reimbursed by the plan are not reportable.

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