Terminated Participants and Plan Fees

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Virginia is representative of a common question on defined contribution plan fees.

"Can a plan charge fees to terminated participants with account balances but not active participants?"

Highlights of the discussion

First and foremost, plan sponsors should consult the language of their plan documents for specific provisions relating to the allocation of plan expenses. It is possible for a plan to charge administrative expenses to terminated participants but not active participants, if the language of the plan document accommodates such a practice. Both the Department of Labor (DOL) and the IRS have concluded that a plan may charge administrative expenses to terminated participants, while not charging active participants, provided the method used meets certain criteria as explained next.

DOL Field Assistance Bulletin (FAB) 2003-3 grants plan sponsors considerable discretion when determining how plan expenses will be allocated among participants and beneficiaries, if the method used

• Is prudent,

• Is done solely in the interest of plan participants, and

• Does not create a prohibited transaction.

An example included in FAB 2003-3 specifically states, “… plans may charge vested separated participant accounts the account’s share (e.g., pro rata or per capita) of reasonable plan expenses, without regard to whether the accounts of active participants are charged such expenses …”

Similarly, the IRS concluded in Revenue Ruling 2004-10 that a plan sponsor may charge certain plan expenses to former plan participants and not active participants, provided the expenses are proper, reasonable and the allocation method is not discriminatory.

Treasury regulations require valid consent for distribution to a participant of amounts over the cash-out limit. For there to be valid consent, the participant cannot be subject to significant detriment based on facts and circumstances. A significant detriment could be unreasonable fees, which may make it problematic to leave the money in the plan [Treas. Reg. 1.411(a)-11(c)(2)].

From the IRS’ perspective, not every method of allocating plan expenses is reasonable. The IRS could deem a method that is not reasonable impermissible. For example, allocating the expenses of active employees pro rata to all accounts, including the accounts of both active and former employees, while 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 could be a significant detriment and, therefore, disallowed.

Conclusion

If the plan includes specific provisions that address the allocation of expenses, the sponsor must follow them. The DOL and IRS have concluded that a plan may charge administrative expenses to terminated participants, while not charging active participants, provided the method is not a breach of fiduciary responsibility, and the expenses are proper, reasonable and done in a nondiscriminatory manner.