A qualified retirement plan incurs a variety of administrative expenses throughout its existence. These include fees for establishment, annual valuations, government reporting requirements, the processing of loans and benefit distributions, and plan termination.

Most plan documents allow administrative expenses to be paid either by the plan sponsor (employer) or, when appropriate, the plan assets. But for many years, that was where the certainty ended and the confusion began. The first uncertainty involved which expenses were allowed to be paid by plan assets. Would the cost to establish a plan be an appropriate expense? What about plan amendments?

The second area of confusion involved the proper method for allocating expenses that could be paid by the plan. Could participants be charged fees that were directly related to their accounts, such as the cost of determining the validity of a Qualified Domestic Relations Order (QDRO)? Or would the entire plan have to share in that expense?

The Department of Labor (DOL) issued a number of opinions over the years attempting to resolve these issues. But most of them were ineffective, at best, and at least one served to deepen the uncertainty. Then in 2001, the DOL issued an advisory opinion that went a long way towards clarifying which expenses could properly be paid by plan assets, as opposed to those considered the responsibility of the employer.

In May of 2003, the DOL issued Field Assistance Bulletin (FAB) 2003-3, which explains in detail the allowable methods for allocating plan expenses among participants. Perhaps most noteworthy of all is the DOL’s complete reversal from its former position on QDRO determination fees. It all spells good news for plan sponsors and fiduciaries, who can now establish policies that are reasonable without fear of repercussion–almost!

Let’s take a close look at the guidance issued by the DOL in FAB 2003-3.

Background

Annual administrative expenses are a normal function of the ongoing operation of a qualified plan, in addition to startup and plan termination costs. Many of these expenses arise pursuant to the qualification requirements of the Internal Revenue Code as well as the Employee Retirement Income Security Act of 1974 (“ERISA”).

Administrative expenses can certainly be paid by the sponsoring employer with no questions asked. In fact, in many cases, that’s how expenses are handled, and the employer deducts the cost as an ordinary business expense. In a traditional employer-funded defined benefit plan, where specific benefits are guaranteed at retirement, it hardly matters whether the employer or the plan pays the expenses. That’s because the employer is required to fund the plan to provide for the guaranteed benefits. If the assets are reduced by expenses, the required employer contribution will increase over the years to offset the loss.

In defined contribution plans, such as 401(k) and other profit sharing plans, benefits are expressed in terms of account balances. Any reduction in plan assets will have to be charged to the accounts of one or more participants, unless expenses are paid from the forfeiture account. If the plan provides that forfeitures will offset future employer contributions, then charges against such account are equivalent to payment by the employer. But where the forfeitures are to be allocated to plan participants, fees that reduce forfeitures indirectly reduce participants’ benefits in a prescribed manner and, in that case, the guidance of FAB 2003-3 must be considered.

The DOL pointed out that ERISA contains no provision specifically addressing the issue of how plan expenses can be allocated among participants. It does, however, provide for the imposition of reasonable charges to provide copies of plan documents and instruments upon request, as well as expenses associated with the exercise of a directed investment option or the processing of a loan. ERISA also provides that certain requested information, such as annual benefit and vesting calculations, be furnished free of charge.

In 1994, the DOL issued an Advisory Opinion concerning the allocation of plan expenses among participants. It provided that fees related to a determination of the validity of a Qualified Domestic Relations Order could not be charged to the participant’s account in question. The reasoning was that the QDRO determination was legally required by ERISA, and so it was considered the exercise of a participant’s legal right. Such costs had to be allocated to the plan as a whole or paid by the employer.

This Advisory Opinion created a great deal of confusion for plan fiduciaries, who wondered if the processing of other entitlements under ERISA, such as benefit distributions, could be charged to a participant’s account. The fact that the DOL’s opinion was limited to the QDRO example, and the distribution issue was not directly addressed at that time, added to the confusion.

DOL Finally Provides Relief

In FAB 2003-3, issued May 19, 2003, the DOL surprised many practitioners by reversing its 1994 position on the allocation of QDRO fees. After reviewing ERISA, the DOL concluded that “plan sponsors and fiduciaries have considerable discretion in determining, as a matter of plan design or a matter of plan administration, how plan expenses will be allocated among participants and beneficiaries.” This Bulletin dealt with two primary issues regarding the allocation of expenses that can properly be charged to a defined contribution plan. They are:

• The allocation of expenses on a pro rata, rather than a per capita basis, and
• The extent to which plan expenses may properly be charged to an individual account, rather than the plan as a whole.

Pro Rata vs. Per Capita

A “pro rata” allocation is based upon a proportional share of plan assets. For example, if participant A’s account balance comprises 10% of all plan assets, his account would bear 10% of the expense allocation. A “per capita” allocation is allocated equally to each participant, regardless of account values.

The DOL stated that where the plan document specifically provides the allocation method to be used, fiduciaries must follow the prescribed method. Failure to do so would be an unauthorized alteration of plan benefits. Absent specific plan provisions, fiduciaries must follow a method that is prudent and solely in the interest of all participants. The method chosen must have a rational basis, with some reasonable relationship to the services provided or available to an individual account.

The DOL’s language on this issue is actually quite general, and few concrete examples were given in the Bulletin. It states that a per capita allocation may be appropriate with certain fixed administrative expenses, such as record keeping, legal, auditing, annual reporting, claims processing, etc. Investment management fees would more likely qualify for the pro rata basis. “With regard to services which provide investment advice to individual participants, a fiduciary may be able to justify the allocation of such expenses on either a pro rata or per capita basis and without regard to actual utilization of the services by particular individual accounts.”

The guidelines for the proper allocation method appear to be broad and open to interpretation. Prudence and reasonableness should be the primary concerns.

Allocating Specific Expenses to Individual Accounts

In FAB 2003-3, the DOL provides new and welcome guidance on charging specific fees to a participant’s account. This differs from the above discussion on allocating expenses among all participants. The DOL referred to its 1994 position on QDRO determination fees, and concluded that “…neither the analyses or conclusions set forth in that opinion are legally compelled by the language of the statute [ERISA].” It noted that ERISA places few constraints on how expenses are allocated among participants, and therefore the same principles applicable to determining the method of allocating expenses among all participants should apply to permissible allocation of specific expenses to individuals rather than the plan as a whole.

On this subject the DOL did provide specific examples of expenses, to the extent they are reasonable, which can be charged to an individual account:

• Hardship withdrawals,
• Calculation of benefits payable under various distribution options,
• Benefit distributions, including periodic check writing expenses, and
• Administrative expenses of accounts of separated vested participants.

Regarding the last item, the DOL stated that it would be reasonable for fiduciaries to charge administrative expenses against accounts of terminated participants even where the plan sponsor pays such expenses for active participants. But it appears that the Internal Revenue Service (IRS) may not be in agreement on this issue.

The IRS expressed reservations on this matter at a recent benefits conference. IRS Director of Rulings and Agreements, Paul Shultz, noted that charging account maintenance fees only to terminated participants could represent a “significant detriment” to such participants, in violation of regulations and plan qualification requirements. Footnote One of the DOL Bulletin stated that “[t]he views set forth herein relate solely to the application of Title I of ERISA. We express no view as to whether any particular allocation of expenses might violate the Internal Revenue Code or any other federal statute.”

The IRS has not yet taken a formal position on the DOL Bulletin but hopes to address it within the next year. In the meantime, plan sponsors should proceed with caution when adopting expense allocation policies.

FAB 2003-3 also specifically allows for the allocation of reasonable expenses pursuant to the determination of a QDRO or QMCSO (Qualified Medical Child Support Order) to the account of the participant or beneficiary seeking the determination. Again, hats off to the DOL for finally seeing the light and correcting the injustice.

Plan Provisions

The Bulletin states that plans must include in the Summary Plan Description information concerning any expenses that could be charged against a participant’s account, ultimately impacting upon benefits. In addition, plan sponsors may want to amend their plan document to include specific provisions for the allocation of expenses. However, an improperly worded amendment could jeopardize the plan’s qualified status, unless an IRS determination letter is requested. Consequently, employers may want to wait until guidance is issued by the IRS before adopting plan amendments, or consider submitting the amendment to the IRS for approval.

Conclusion

New guidance from the DOL on the proper allocation methods for plan expenses is a breath of fresh air to sponsors and fiduciaries of 401(k) and other defined contribution plans. It includes a complete reversal of the DOL’s prior position on QDRO determination fees, with additional guidance applicable to other individual expenses. Prudence and reasonableness are the primary factors to consider when drafting policies for allocating certain expenses among all participants. But the latest Bulletin, in conjunction with the DOL’s 2001 opinion differentiating employer expenses from plan expenses, goes a long way towards clarifying the proper handling of plan expenses.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.