As a way to better manage the cost of administering a plan, employers frequently ask about the options for allocating plan expenses to participants. These discussions may focus on several related issues including whether charging such accounts to former employees can legally rid the plan of accounts from the plan and to also encourage former employees with larger accounts to agree to take distributions.
Additionally, removing small accounts of former employees from a plan may arise when a participant eligible to receive a distribution cannot be found or the participant has been found but just doesn’t respond to a distribution notice. Where the account is too small (under $1,000) to force out as an automatic IRA rollover, the employer really has few options in removing those accounts. So what can be done to rid the plan of small accounts under $1,000?
One approach is to impose an annual per capita fee of, say $25 for example, to each account of all terminated participants with a vested balance that are still held by the plan as a recordkeeping expense. Such a charge will of course need to be permitted under the terms of the plan document. In 2003, the Department of Labor released guidance in a field assistance bulletin, FAB 2003-3, allowing this type of charge, as discussed in more detail below.
This DOL guidance was discussed by Treasury in Rev. Rul. 2004-10. There the IRS addressed a qualified defined contribution plan that permitted participants to elect withdrawal of their vested account anytime after a termination of employment up until the plan’s normal retirement age. The plan provided that certain administrative expenses – such as investment management fees – would be allocated pro rata (based on each account’s assets as a percent of all plan assets) to the individual accounts of all participants and beneficiaries based on the value of their account balances in the plan. The plan also provided that any account’s share of the expenses that were not paid by the employer would be charged against the account. This employer paid plan costs only for active employees. Thus, the cost associated with the accounts of former employees or their beneficiaries was charged directly to those accounts. The Service ruled that the charges represented proper and reasonable plan expenses under ERISA.
The legal question was whether such a charge made only to the accounts of terminated participants represented an impermissible “significant detriment” to those participants who did not consent to a distribution and violated IRC 411(d)(11). That section prohibits the distribution of a terminated participant’s account without the consent of the participant when the benefit exceeds $5,000. The question here was did the imposition of such a charge to only the terminated participants or beneficiaries impose a significant detriment to the participant that did not consent to a distribution so that the significant detriment rule was violated. That is, was the participant being improperly coerced to make the distribution election now rather than leave the funds in the plan?
Treas. Reg. 1.411(a)-11(c)(2)(i) permits a pro rata allocation of proper plan expenses to all plan accounts. The Service ruled that the proposed allocation only to terminated employees’ accounts does not impose a detriment so significant as to be inconsistent with the deferral rights mandated by IRC § 411(a)(11) because similar fees would be imposed in the marketplace for a comparable investment outside the plan.
Rev. Rul. 2004-10 provides that not every method of allocating plan expenses is reasonable, and a method that is not reasonable could result in a significant detriment. For example, allocating the expenses of only active employees pro rata to all accounts (current employees and former employees), while also allocating the expenses of former employees only to their accounts, would not be reasonable since former employees would be bearing more than an equitable portion of the plan’s expenses. Accordingly, such an allocation of expenses is a significant detriment.
FAB 2003-3 sanctions equal (per capita) allocation of charges to each account in the case of fixed administrative expenses, such as recordkeeping, legal, auditing, and annual reporting, claims processing, and similar administrative expenses. However, where fees are determined pro rata based on account balances, such as investment management fees, FAB 2003-3 indicates that a per capita allocation method would be arbitrary. With respect to investment advice expenses, FAB 2003-3 sanctions either pro rata or per capita, and whether or not based on actual utilization.
Finally, FAB 2003-3 FAB 2003-3 notes the following as specific examples of the types of expenses that can be charged directly to a participant’s account, provided the expense is reasonable: (1) hardship withdrawals, (2) calculation of benefits payable under different distribution options, (3) benefit distributions, (4) accounts of separated participants (may be charged for a portion of the plan’s administrative expenses), and (5) QDRO expenses.
Finally, the allocation of plan expenses must also comply with the nondiscrimination rules of IRC § 401(a)(4). The method of allocating plan expenses is a plan right or feature described under § 1.401(a)(4)-4(e)(3)(i). For example, if, in anticipation of the divorce of a plan participant who is a highly compensated employee, the plan’s method of allocating expenses is changed so that the expense of a determination of whether an order constitutes a qualified domestic relations order under § 414(p) ceases to be allocated solely to the account of the participant for whom the expense is incurred, but instead is allocated pro rata to all accounts, the timing of such change may cause the plan to fail to satisfy the requirements of § 1.401(a)(4)-1(b)(3) and (4) with respect to the nondiscriminatory availability of benefits, rights and features and with respect to the timing of plan amendments.
The bottom line summary is that a plan may impose reasonable expenses to only former employees as long as the requirements discussed above are followed.
Greg Matthews, Matthews Benefit Group, Inc., St. Petersburg, Florida