Allocating Administrative Costs in Defined Contribution Retirement Plans

“vested separated participant accounts … without regard to whether the accounts of active participants are charged such expenses and without regard to whether the vested former participant was afforded the option of withdrawing the funds from his or her account or the option to roll the funds over to another plan or [IRA].”

To charge a single participant's account for expenses solely attributable to the participant. The FAB identifies four types of expenses that a plan may charge separately to the account of the participant to whom the charge relates. These expenses relate to:

Finally, the FAB acknowledges that plan fiduciaries have the discretion to apportion broad-based plan expenses, eg, recordkeeping and investment fees, on a per capita basis or according to relative account balances. The DOL warns, however, that it would be a breach of fiduciary duty to charge expense to accounts per capita if the expenses are assessed on a percentage of assets basis.

Implementation: Primary Steps and Pitfalls

When fiduciaries are deciding how to allocate plan expenses between participant accounts, they are subject to ERISA's fiduciary duty rules. The FAB recognizes that fiduciaries normally will have this type of discretion even when plans do not explicitly give it to them. Footnote 7 of the FAB provides in particular that “in reviewing the propriety of such fiduciary actions, the judicial standard is whether the fiduciary acted in an arbitrary and capricious manner.”

Plan fiduciaries who decide to charge plan expenses to participant accounts should consequently record their decisions in administrative resolutions (or some other writings). Their resolutions should record their decisions, demonstrate that they resulted from an appropriate balancing of the interests of different classes of participants, and establish an appropriate correlation between the expense and the method for its allocation (eg, per capita or pro rata per account balance).

Before making any change, however, plan fiduciaries should take note that ERISA's fiduciary duty rules are not the only laws that may regulate expense allocations. For example, Internal Revenue Code regulations prohibit a plan from imposing a “significant detriment” on participants who elect against an immediate distribution of their accounts when they terminate employment. See Treas. Reg. '1.411(a)-11(c)(2)(i). In Revenue Ruling 96-47, for example, the IRS ruled that a plan which permitted active participants to direct their account investments but did not permit terminated participants the same right was placing a significant detriment on the failure of a participant to elect a distribution following termination. The FAB does not address whether charging more administrative expenses to former employees' accounts than to current employees' accounts would violate this prohibition.

Finally, and perhaps critical to avoiding disputes with participants, the FAB concludes with a warning ' that summary plan descriptions must disclose “fees and charges that may affect … benefit entitlements.” Hence, plan fiduciaries should make sure that all participants in defined contribution plans receive adequate disclosure of any circumstances under which a plan will charge their accounts for administrative expenses.

Other Plans

The DOL's analysis in the FAB does not readily apply to defined benefit plans, including cash balance plans, pay equity plans, and target benefit plans. The latter are hybrid plans that involve hypothetical individual accounts ' meaning the plan bears the responsibility to provide the full benefit, without reduction for plan expenses.

By contrast, a money purchase pension plan is generally considered to be more akin to a defined contribution plan, because participants bear the risk and reward of plan investments. These plans may fall within the scope of the FAB, but their defined benefit characteristics should prompt plan fiduciaries to seek further counsel before proceeding on this basis.

Welfare plans pose a separate and distinct question that are beyond the scope of this article.

Conclusion

The FAB now makes it possible for defined contribution plans to allocate their administrative expenses in more targeted ways than the DOL has allowed in the past. Many employers and plan participants will regard it as reasonable and fair to charge specific plan expenses against the accounts of the participants who generated the expense. Before making any changes, however, fiduciaries should make sure that the changes will not cause an unanticipated uproar among plan participants, will be consistent with plan terms and the FAB, and will be adequately documented and disclosed to participants.

Whether or not the fiduciaries of a defined contribution plan want to make changes in response to the FAB, they should confirm that any existing expense allocation method is permissible and adequately disclosed to participants.

The Employee Benefit Security Administration of the Department of Labor (DOL) has recently announced a more liberal view toward charging tax-qualified retirement plan expenses against the accounts of participants in 401(k), ESOP, and other defined contribution plans. This article provides a brief overview of the kinds of expenses that plans may pay, and explains how the new DOL guidance provides employers and plan sponsors with greater flexibility in allocating these expenses to participant accounts.

Expenses that Plans May Pay:
Administrative v. Settlor Decisions

Employers are not required to pay all costs associated with the maintenance of their tax-qualified retirement plans. While the DOL has long recognized that there are occasions under which plans may pay plan expenses, most employers proceed with caution in deciding to pay plan expenses from plan assets, because that decision is a fiduciary act under the Employee Retirement Income Security Act (ERISA).

Specifically, ERISA provides that, subject to certain exceptions, the assets of an employee benefit plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. ERISA Section 403(c)(1). Further, in discharging their duties under ERISA, fiduciaries must act prudently and solely in the interest of the plan participants and beneficiaries, and in accordance with the documents and instruments governing the plan provided they are consistent with the provisions of ERISA. ERISA Section 404(a)(1)(A).

The DOL has long taken the position that the above provisions prohibit an employer or other plan fiduciary from using plan assets to pay for expenses associated with decisions relating to the establishment, design, and termination of a plan. See, eg, Letter from DOL's Pension Welfare Benefit Administration to Kirk F. Maldonado (March 2, 1987). These so-called “settlor” functions are presumed to arise from an employer's sponsorship of a plan, and to involve decisions that employers make in their own best interests. Consequently, the DOL requires that employers bear all costs leading up to any settlor decision. See, eg, DOL Adv. Op. Ltr. 2001-01A (January 18, 2001).

Once an employer makes a settlor decision, plan assets may pay any expenses incurred to implement that decision. Id. Employers often pay a plan's administrative costs, but are not required to do so. When they do not, plan fiduciaries have the authority to use plan assets to pay reasonable expenses of administering a plan, including direct expenses properly and actually incurred in the performance of a fiduciary's duties to the plan. See, eg, DOL Adv. Op. Ltr. 2001-01A (January 18, 2001). Thus, for example, once a plan sponsor has decided to terminate a plan, the reasonable expenses incurred in implementing a plan termination would generally be payable by the plan. DOL Adv. Op. Ltr. 97-03A (January 23, 1987) (stating that these expenses would typically include “auditing the plan, preparing and filing annual reports, preparing benefit statements and calculating accrued benefits, notifying participants and beneficiaries of their benefits under the plan and, in certain circumstances, amending the plan to effectuate an orderly termination that benefits the participants and beneficiaries”).

The chart below summarizes some examples of the types of plan expenses that the DOL has classified as settlor and administrative, disclosed in Advisory Opinion 2001-01A.

[IMGCAP(1)] 

Even if an expense qualifies as an administrative expense that may be paid with plan assets, a plan sponsor should confirm that the payment of that expense is permissible under the plan document. The DOL has taken the position that when a plan document is silent regarding the payment of administrative expenses, the plan may pay reasonable administrative expenses. Even when a plan document provides that the employer will pay any such expenses, if the employer has reserved the right to amend the plan document, ERISA permits the employer to amend the plan to require the plan to pay administrative expenses but only on a prospective (not retroactive) basis. DOL Adv. Op. Ltr. 2001-01A, fn. 5.

Allocating Plan Expenses in a Defined Contribution Plan

Traditional pension or defined benefit pension plans do not involve individual accounts for participants, because these plans merely promise a formula-based retirement benefit and place full funding responsibility on the employers who sponsor them. When these plans incur administrative expenses, plan assets may pay them ' but this does not affect the retirement benefits that participants will ultimately receive.

Defined contribution plans are fundamentally different in this respect, because they require an allocation of plan assets between the accounts of participants. Investment gains and losses pass through to the accounts of participants. Administrative expenses will also pass through to the accounts of participants, unless the employer pays them. Until recently, prior DOL pronouncements effectively prevented defined contribution plans from charging a participant's account for plan expenses specifically attributable to the account. (For example, the DOL had previously ruled that imposing the costs of a QDRO determination solely on the participant (or alternate payee) seeking the QDRO would violate ERISA and that such an expense had to be allocated over the plan as whole. DOL Adv. Op. Lt. 94-32A (August 4, 1994).) This forced plans to divide administrative expenses between all plan participants' accounts.

In Field Assistance Bulletin 2003-3 (FAB), the DOL expressly stated that defined contribution plans need not treat all participants alike when allocating administrative expenses to participants. This opens the door for passing a plan's administrative expenses through to participants in appealing new ways. The FAB permits a plan:

To charge plan expenses to the accounts of former employees, but not necessarily to those of active employees. According to the FAB, it is permissible for a plan to assess administrative expenses against:

“vested separated participant accounts … without regard to whether the accounts of active participants are charged such expenses and without regard to whether the vested former participant was afforded the option of withdrawing the funds from his or her account or the option to roll the funds over to another plan or [IRA].”

To charge a single participant's account for expenses solely attributable to the participant. The FAB identifies four types of expenses that a plan may charge separately to the account of the participant to whom the charge relates. These expenses relate to:

Finally, the FAB acknowledges that plan fiduciaries have the discretion to apportion broad-based plan expenses, eg, recordkeeping and investment fees, on a per capita basis or according to relative account balances. The DOL warns, however, that it would be a breach of fiduciary duty to charge expense to accounts per capita if the expenses are assessed on a percentage of assets basis.

Implementation: Primary Steps and Pitfalls

When fiduciaries are deciding how to allocate plan expenses between participant accounts, they are subject to ERISA's fiduciary duty rules. The FAB recognizes that fiduciaries normally will have this type of discretion even when plans do not explicitly give it to them. Footnote 7 of the FAB provides in particular that “in reviewing the propriety of such fiduciary actions, the judicial standard is whether the fiduciary acted in an arbitrary and capricious manner.”

Plan fiduciaries who decide to charge plan expenses to participant accounts should consequently record their decisions in administrative resolutions (or some other writings). Their resolutions should record their decisions, demonstrate that they resulted from an appropriate balancing of the interests of different classes of participants, and establish an appropriate correlation between the expense and the method for its allocation (eg, per capita or pro rata per account balance).

Before making any change, however, plan fiduciaries should take note that ERISA's fiduciary duty rules are not the only laws that may regulate expense allocations. For example, Internal Revenue Code regulations prohibit a plan from imposing a “significant detriment” on participants who elect against an immediate distribution of their accounts when they terminate employment. See Treas. Reg. '1.411(a)-11(c)(2)(i). In Revenue Ruling 96-47, for example, the IRS ruled that a plan which permitted active participants to direct their account investments but did not permit terminated participants the same right was placing a significant detriment on the failure of a participant to elect a distribution following termination. The FAB does not address whether charging more administrative expenses to former employees' accounts than to current employees' accounts would violate this prohibition.

Finally, and perhaps critical to avoiding disputes with participants, the FAB concludes with a warning ' that summary plan descriptions must disclose “fees and charges that may affect … benefit entitlements.” Hence, plan fiduciaries should make sure that all participants in defined contribution plans receive adequate disclosure of any circumstances under which a plan will charge their accounts for administrative expenses.

Other Plans

The DOL's analysis in the FAB does not readily apply to defined benefit plans, including cash balance plans, pay equity plans, and target benefit plans. The latter are hybrid plans that involve hypothetical individual accounts ' meaning the plan bears the responsibility to provide the full benefit, without reduction for plan expenses.

By contrast, a money purchase pension plan is generally considered to be more akin to a defined contribution plan, because participants bear the risk and reward of plan investments. These plans may fall within the scope of the FAB, but their defined benefit characteristics should prompt plan fiduciaries to seek further counsel before proceeding on this basis.

Welfare plans pose a separate and distinct question that are beyond the scope of this article.

Conclusion

The FAB now makes it possible for defined contribution plans to allocate their administrative expenses in more targeted ways than the DOL has allowed in the past. Many employers and plan participants will regard it as reasonable and fair to charge specific plan expenses against the accounts of the participants who generated the expense. Before making any changes, however, fiduciaries should make sure that the changes will not cause an unanticipated uproar among plan participants, will be consistent with plan terms and the FAB, and will be adequately documented and disclosed to participants.

Whether or not the fiduciaries of a defined contribution plan want to make changes in response to the FAB, they should confirm that any existing expense allocation method is permissible and adequately disclosed to participants.