A prohibited transaction is a retirement plan deal ERISA does not allow. Learn what counts, who is involved, and how to avoid costly violations.
A Prohibited Transaction is a financial transaction involving a retirement plan’s assets that is specifically forbidden under the Employee Retirement Income Security Act (ERISA). These rules are designed to protect plan participants by ensuring that plan assets are used solely for their benefit—not for the personal gain of employers, fiduciaries, or anyone closely connected to the plan.
Below is a simple, clear explanation of what prohibited transactions are, why they matter, and how employers and fiduciaries can avoid them.
What Is a Prohibited Transaction?
At its core, a Prohibited Transaction is any transaction between a retirement plan—such as a 401(k), pension plan, or profit-sharing plan—and a “party in interest.” ERISA uses this term to describe certain individuals or businesses closely tied to the plan.
Prohibited transactions usually involve actions that could create conflicts of interest or misuse of plan resources. Because retirement plans hold employees’ money, ERISA requires strong safeguards to prevent abuse.
Who Is Considered a “Party in Interest”?
A party in interest is anyone who has a direct or indirect relationship with the retirement plan. This group is intentionally broad to prevent potential self-dealing.
Under ERISA, a party in interest can include:
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The employer sponsoring the plan
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Plan fiduciaries (e.g., HR administrators, plan trustees)
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Corporate officers or directors
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Employees who provide services to the plan
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Plan service providers (accountants, attorneys, advisors)
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Certain owners or shareholders
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Immediate family members of the above
If any of these individuals or businesses conduct certain types of transactions with the plan, it may trigger a prohibited transaction violation.
Common Examples of Prohibited Transactions
Understanding real-world examples makes this rule easier to apply. Some of the most common prohibited transactions include:
1. Selling or leasing property to the plan
Example: The employer sells office space to the plan at a “special price.”
This is not allowed—even if the plan benefits financially.
2. Lending money to or from the plan
Example: A fiduciary borrows money from the plan to cover short-term business expenses.
3. Using plan assets for personal benefit
Example: A corporate officer uses plan funds to pay company bills.
Even temporary use is considered misuse.
4. Paying unreasonable compensation
Example: A service provider charges excessive fees without justification.
5. Self-dealing by fiduciaries
Example: A fiduciary approves an investment in a company they own.
These situations violate ERISA because they put personal or corporate interest ahead of employees’ retirement security.
Why Prohibited Transactions Matter
Prohibited transactions come with serious consequences, including:
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IRS excise taxes (often up to 15% or 100% of the transaction amount)
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Required correction of the transaction
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Personal liability for fiduciaries
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Potential civil penalties from the Department of Labor
Because the risks are high, understanding what counts as a prohibited transaction is essential for anyone managing retirement plans.
How to Avoid Prohibited Transactions
Here are some practical ways employers and fiduciaries can prevent violations:
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Identify all parties in interest connected to the plan.
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Avoid any business or personal transactions using plan assets.
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Hire independent service providers to evaluate fees and investments.
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Document all fiduciary decisions and keep records updated.
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When in doubt, seek legal or compliance guidance.
For example, if a fiduciary wants to lease office space to the plan, they should stop immediately—no amount of documentation can make it ERISA-compliant.
Final Summary
A Prohibited Transaction occurs when a retirement plan engages in a transaction with a “party in interest” that ERISA specifically forbids. These rules prevent conflicts of interest, protect participants’ assets, and ensure fiduciaries act solely in the best interest of the plan. By carefully identifying parties in interest, avoiding self-dealing, and maintaining clear documentation, employers and fiduciaries can stay compliant and protect both the plan and its participants.
Understanding what is—and isn’t—allowed under ERISA helps keep retirement plans safe, fair, and aligned with long-term financial security.
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