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May 19, 2003
Memorandum for: Virginia C. Smith
Director of Enforcement, Regional Directors
From: Robert J. Doyle
Director of Regulations and Interpretations
Subject: Allocation of Expenses in a Defined
Contribution Plan
What rules apply to how expenses are allocated among plan participants in a
defined contribution pension plan?
A number of questions have been raised in the course of
investigations and otherwise concerning the propriety of certain expense
allocation practices in defined contribution plans. This memorandum is
intended to respond to the various requests for guidance from the National
and Regional Offices on these issues.(1)
The two principal issues raised with respect to the
allocation of plan expenses in defined contribution plans involve the extent
to which plan expenses are required to be allocated on a pro rata, rather
than per capita, basis and the extent to which plan expenses may properly be
charged to an individual participant, rather than plan participants as a
whole. For purposes of discussing these issues, we assume first that the
expenses at issue are proper plan expenses(2)
and second that, with respect to the plan as a whole, the amount of the
expenses at issue are reasonable with respect to the services to which they
relate.
ERISA contains no provisions specifically addressing how
plan expenses may be allocated among participants and beneficiaries. The Act
and implementing regulations, however, do address certain instances in which
a plan may impose charges on particular participants and beneficiaries. For
example, section 104(b)(4) provides that the plan administrator may impose a
reasonable charge to cover the cost of furnishing copies of plan documents
and instruments upon request of a participant or beneficiary.(3)
Also, section 602 permits group health plans, subject to certain conditions,
to require the payment of 102% of the applicable premium for any period of
continuation coverage elected by an eligible participant or beneficiary.
Further, the Department’s regulations under sections 404(c) and 408(b)(1)
provide that reasonable expenses associated with a participant’s exercise
of an option under the plan to direct investments or to take a participant
loan may be separately charged to the account of the individual participant.(4)
By contrast, regulations may limit the ability of a plan to charge a
particular participant or beneficiary by requiring that information be
furnished free of charge upon request of a participant or beneficiary.(5)
Section 404(a)(1) generally provides, in relevant part,
that fiduciaries shall discharge their duties with respect to a plan “solely
in the interest of the participants and beneficiaries,” prudently
(404(a)(1)(B)), and “in accordance with the documents and instruments
governing the plan insofar as such documents and instruments are consistent
with the provisions of [Title I] . . . ” (404(a)(1)(D)). Plan fiduciaries,
therefore, would be required to implement allocation of expense provisions
set forth in the plan, unless such provisions otherwise violate Title I.
Accordingly, 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.
Allocating Expenses Among All Participants - Pro rata
v. Per capita
In analyzing formulas for allocating expenses among all
plan participants, the starting point is a review of the instruments
governing the plan. Inasmuch as ERISA does not specifically address the
allocation of expenses in defined contribution plans, a plan sponsor, as
noted above, has considerable discretion in determining the method of
expense allocation. Where the method of allocating expenses is determined by
the plan sponsor (i.e., set forth in the plan documents), fiduciaries,
consistent with section 404(a)(1)(D), will be required to follow the
prescribed method of allocation. The fiduciary’s obligation in this regard
does not change merely because the allocation method favors a class (or
classes) of participants. When set forth in plan documents, the method of
allocating expenses, in effect, becomes part of defining the benefit
entitlements under the plan.(6)
When the plan documents are silent or ambiguous on this
issue, fiduciaries must select the method or methods for allocating plan
expenses. A plan fiduciary must be prudent in the selection of the method of
allocation. Prudence in such instances would, at a minimum, require a
process by which the fiduciary weighs the competing interests of various
classes of the plan’s participants and the effects of various allocation
methods on those interests. In addition to a deliberative process, a
fiduciary’s decision must satisfy the “solely in the interest of
participants” standard. In this regard, a method of allocating expenses
would not fail to be “solely in the interest of participants” merely
because the selected method disfavors one class of participants, provided
that a rational basis exists for the selected method.(7)
On the other hand, if a method of allocation has no reasonable relationship
to the services furnished or available to an individual account, a case
might be made that the fiduciary breached his fiduciary duties to act
prudently and “solely in the interest of participants” in selecting the
allocation method. Further, in the case where the fiduciary is also a plan
participant, the selection of the method of allocation may raise issues
under the prohibited transaction provisions of section 406 of ERISA where
the benefit to the fiduciary is more than merely incidental.(8)
For example, if in anticipation of the plan fiduciary’s own divorce, the
fiduciary who is also a plan participant decides to change the allocation of
expenses related to a determination of whether a domestic relations order
constitutes a “qualified” order from the account incurring the expense
to the plan as a whole, such change in allocation by the fiduciary could
constitute an act of self-dealing under section 406 of ERISA.
While a pro rata method of allocating expenses among
individual accounts (i.e., allocations made on the basis of assets in the
individual account) would appear in most cases to be an equitable method of
allocation of expenses among participants, it is not the only permissible
method. A per capita method of allocating expenses among individual accounts
(i.e., expenses charged equally to each account, without regard to assets in
the individual account) may also provide a reasonable method of allocating
certain fixed administrative expenses of the plan, such as recordkeeping,
legal, auditing, annual reporting, claims processing and similar
administrative expenses. On the other hand, where fees or charges to the
plan are determined on the basis of account balances, such as investment
management fees, a per capita method of allocating such expenses among all
participants would appear arbitrary. 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. Investment advice services might also be charged on a
utilization basis, as discussed below, whereby the expense will be allocated
to an individual account solely on the basis of a participant’s
utilization of the service.
Allocating Expenses to an Individual v. General Plan
Expense
In contrast to the preceding discussion, which focused on
methods of allocating plan expenses among all participants, the following
discussion focuses on the extent to which an expense may be allocated (or
charged) solely to a particular participant’s individual account, rather
than allocated among the accounts of all participants (e.g., on a pro rata
or per capita basis). The Department provided some guidance on this issue in
Advisory Opinion No. 94-32A. In analyzing the extent to which a plan may
charge a participant (or alternate payee) for a determination as to whether
a domestic relations order constitutes a “qualified” order, the
Department concluded in AO 94-32A that imposing the costs of a QDRO
determination solely on the participant (or alternate payee) seeking the
QDRO, rather than the plan as a whole, would violate ERISA.
Since the issuance of AO 94-32A, the Department has had
an opportunity to review the Act and the opinion in the context of a broader
array of plan expense allocation issues raised in the course of
investigations. On the basis of this review, the Department has determined
that neither the analyses or conclusions set forth in that opinion are
legally compelled by the language of the statute. Except for the few
instances in which ERISA specifically addresses the imposition of expenses
on individual participants, the statute places few constraints on how
expenses are allocated among plan participants. In this regard, the same
principles applicable to determining the method of allocating expenses among
all participants, as discussed above, apply to determining the
permissibility of allocating specific expenses to the account of an
individual participant, rather than the plan as a whole (i.e., among all
participants).(9)
Examples of Specific Plan Expenses
Hardship Withdrawals. Some plans may provide for
the allocation of administrative expenses attendant to hardship withdrawal
distributions to the participant who seeks the withdrawal. ERISA does not
specifically preclude the allocation of reasonable expenses attendant to
hardship withdrawals to the account of the participant or
beneficiary seeking the withdrawal.
Calculation of Benefits Payable under Different Plan
Distribution Options. Some defined contribution plans may charge
participants for a calculation of the benefits payable under the different
distribution options available under the plan (e.g., joint and survivor
annuity, lump sum, single life annuity, etc.). ERISA does not specifically
preclude the allocation of reasonable expenses attendant to the calculation
of benefits payable under different distribution options available under the
plan to the account of the participant or beneficiary seeking the
information.
Benefit Distributions. Some plans provide for the
imposition of benefit distribution charges on the participant to whom the
distribution is being made. These charges may be assessed for benefit
distributions paid on a periodic basis (e.g., monthly check writing
expenses). ERISA does not specifically preclude the allocation of reasonable
expenses attendant to the distribution of benefits to the account of the
participant or beneficiary seeking the distribution.
Accounts of Separated Vested Participants. Some
plans, with respect to which the plan sponsor generally pays the
administrative expenses of the plan, provide for the assessment of
administrative expenses against participants who have separated from
employment. In general, it is permissible to charge the reasonable expenses
of administering a plan to the individual accounts of the plan’s
participants and beneficiaries. Nothing in Title I of ERISA limits the
ability of a plan sponsor to pay only certain plan expenses or only expenses
on behalf of certain plan participants. In the latter case, such payments by
a plan sponsor on behalf of certain plan participants are equivalent to the
plan sponsor providing an increased benefit to those employees on whose
behalf the expenses are paid. Therefore, 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 and without regard to whether the
vested separated 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 individual retirement account.
Qualified Domestic Relations Orders (QDROs) and
Qualified Medical Child Support Order (QMCSOs) Determinations. ERISA
does not, in our view, preclude the allocation of reasonable expenses
attendant to QDRO or QMCSO determinations to the account of the participant
or beneficiary seeking the determination.(10)
It should be noted that, pursuant to 29 CFR §
2520.102-3(l), plans are required to include in the Summary Plan Description
a summary of any provisions that may result in the imposition of a fee or
charge on a participant or beneficiary, or the individual account thereof,
the payment of which is a condition to the receipt of benefits under the
plan. In addition, § 2520.102-3(l) provides that Summary Plan Descriptions
must include a statement identifying the circumstances that may result in
the “ . . . offset, [or] reduction . . . of any benefits that a
participant or beneficiary might otherwise reasonably expect the plan to
provide on the basis of the description of benefits . . .” These
requirements are intended to ensure that participants and beneficiaries are
apprised of fees and charges that may affect their benefit entitlements.
Questions concerning the information contained in this
Bulletin may be directed to the Division of Fiduciary Interpretations,
Office of Regulations and Interpretations, 202.693.8510.
-
The 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.
-
See Advisory Opinion No. 2001-01A and
related hypotheticals for discussion of the principles applicable to
distinguishing settlor from plan expenses.
-
See § 29 CFR 2520.104b-30. See also
§ 2520.104-4(b)(2)(ii).
-
See § 2550.404c-1(b)(2)(ii)(A) and 54
FR 30520, 30522 (July 20, 1989)(preamble to 29 CFR § 2550.408b-1).
-
See §§ 2520.104-46(b)(1)(i)(C),
2520.104b-1(c)(1)(iii) and (iv), 2520.104b-30.
-
If a plan is intended to be a tax
qualified plan, the fiduciary would have a duty to assure that the
allocation method does not negatively affect the tax qualified status of
the plan.
-
In reviewing the propriety of such
fiduciary actions, the judicial standard is whether the fiduciary acted
in an arbitrary or capricious manner. In meeting this standard, the
fiduciary has a duty of impartiality to all the plan’s participants
and may appropriately balance the interests of different classes of
participants in evaluating a proposed method of expense allocation. See
Varity Corp. v. Howe, 516 U.S. 489, 514 (1996); Restatement (Second) of
Trusts §183.
-
See Advisory Opinion No. 2000-10A.
-
The views expressed herein supersede
the views expressed in AO 94-32A.
-
See footnote 9.
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