The Department of Labor (DOL) has issued long awaited guidance regarding: (1) the allocation of plan expenses in a defined contribution plan; and (2) the propriety of charging participant’s for the cost of plan distributions. The guidance is significant because it rescinds a DOL position that many practitioners used as the basis for preventing plans from charging participant’s accounts for distributions.

ERISA provides little guidance on the allocation of plan expenses in a defined contribution plan. In fact, ERISA imposes only the following conditions with respect to the plan payment of expenses: (1) plan expenses must be reasonable; and (2) the expenses must be proper plan expenses. Since ERISA does not provide specific guidance with respect to the allocation of expenses, ERISA grants to the plan fiduciary (e.g., employer) wide discretion in determining the method of expense allocation. If the plan document specifies a method for allocating expenses, the plan fiduciary generally should follow the plan terms unless the terms are discriminatory. When the plan document is silent or ambiguous with respect to expense allocation, the plan fiduciary must be prudent and must select a method consistent with the fiduciary’s duty to act “solely in the interest of the participants and beneficiaries.” A plan fiduciary who also is a plan participant must be careful that he/she does not breach his/her fiduciary responsibility or commit a prohibited transaction by making a decision regarding allocation of expenses that primarily benefits the fiduciary.

Example: Corporation X maintains a profit sharing plan for which Tom, the owner of X, is the trustee. The plan provides for allocating QDRO expenses to the account of the participant who is subject to the domestic relations order. Tom is in the process of obtaining a divorce and he decides to amend the plan to allocate the QDRO expenses on a pro rata basis against all plan accounts. Tom probably has violated his fiduciary duty and committed a prohibited transaction because his decision to amend benefits himself and is not in the sole interest of the participants and beneficiaries.

Note: If the plan had included a pro rata allocation of expenses from the outset or long before Tom contemplated divorce, the allocation of the expense to the entire plan would have been permissible.

Pro-rata vs. Per Capita. The DOL guidance indicates that the allocation of expenses on a pro rata basis (i.e., proportionate to account balances) probably is the most equitable method. However, the allocation of certain fixed administrative expenses (e.g., recordkeeping, legal, auditing, Form 5500 preparation and claims processing) on a per capita basis (i.e., dividing the expenses by the number of accounts) also might be reasonable. However, the DOL is careful to point out that the method of allocating expenses must comply with IRS qualification requirements (i.e., the nondiscrimination requirements). Since a plan that allocates expenses on a per capita basis, has the potential for discrimination, the plan may need to take additional precautions. For example, the plan may want to: (1) include specific plan language describing the method for allocating expenses; and (2) obtain a determination letter with respect to the expense allocation language. Furthermore, a plan that uses the per capita method should make certain that such expense allocation does not result in unreasonable allocations. For example, if a plan with 10 participants incurs administrative expense of $3,000 and allocates the expense on a per capita basis, the plan might allocate a $300 expense to a participant with a relatively small account balance (e.g., $500). Although the guidance does not discuss such a scenario, the DOL and the IRS likely would have concerns with such an allocation of expenses.

Investment Management Fees. The DOL indicated that a fiduciary would be acting in an arbitrary manner if it allocated investment fees determined on the basis of account balances on a per capita basis. However, the plan could charge for investment advice services on a utilization basis.

Individual vs. General Expenses. In DOL Advisory Opinion 94-32A, the DOL indicated that since ERISA requires a plan to include QDRO provisions, the plan could not allocate such expenses to the participant subject to the domestic relations order. Instead, ERISA requires the plan to allocate QDRO expenses as a general plan expense. Based on the reasoning of that opinion, many practitioners concluded that a plan also could not charge individual participants for plan distributions. However, the DOL concluded that ERISA does not require the position advanced in the opinion. Therefore, the DOL has rescinded the opinion.

Distribution Expenses. The rescission of Advisory Opinion 94-32A allows a plan to allocate expenses associated with a plan distribution, including a QDRO or a hardship withdrawal, to the participant requesting such a distribution or the plan may treat the expense as a general plan expense. For example, an employer that has charged the expenses associated with distributions as a general plan expense can amend its plan (or merely change its distribution policy) to impose a reasonable fee on participants requesting a distribution. Alternatively, the employer could limit the participant charge to participants requesting specified types of distribution such as a hardship withdrawal. The DOL guidance also allows the plan to charge a participant’s account for the calculation of the benefits under the different distribution options available under the plan (e.g., joint and survivor annuity, installments).

The DOL guidance permits a plan to charge the expenses related to a QDRO or QMCSO (qualified medical child support order) to the account of the participant for whom the plan is making the determination. For example, if Frank is obtaining a divorce, the plan may charge his account for the costs associated with reviewing and processing a QDRO.

Terminated Participants. Employees with account balances in excess of $5,000 may choose to leave their accounts in the plan until the later of age 62 or normal retirement age. Employers who pay plan expenses generally prefer not to pay plan expenses for terminated participants who have left their accounts in the plan. However, because the regulations under Code §411 state that a plan may not impose a significant detriment on a participant who leaves his/her account in the plan, many plans have chosen not to charge terminated participants for such costs. The DOL guidance permits a plan to charge terminated participant accounts for administrative expenses irrespective of whether the plan charges the expenses to the accounts of the active participants. Furthermore, the plan may charge a terminated participant’s account for administrative expenses irrespective of whether the plan provides the terminated participant the right to withdraw his/her distribution upon termination of employment.

Although the DOL guidance makes clear that DOL will permit charging terminated participants for account related expenses, the DOL does not express any opinion about compliance with the Code. This leaves somewhat in doubt the question of whether the IRS would challenge this practice as constituting a significant detriment under the Treasury regulations.

Summary Plan Description (SPD). A plan that allocates certain expenses to a participant’s account needs to include a provision in the SPD describing the circumstances under which the plan may charge a participant’s account. This requirement will require a plan sponsor wishing to take advantage of the new DOL guidance to revise its SPD accordingly. Field Assistance Bulletin 2003-3.

Note: The DOL guidance does not require any changes to a plan document. Furthermore, since modification to a pre-approved document (prototype or volume submitter) would require resubmission to the IRS, we do not intend to make any changes to the plan documents. However, after resolving certain issues with the IRS, we will add some language options to our SPD and provide a sample summary of material modifications.