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.
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