IRS Issues Guidance Clarifying Allocation of Plan Expenses to Inactive Participants

In 2003, the Department of Labor issued Field Assistance Bulletin 2003–3 (the “FAB”), which provides guidance on the allocation of expenses paid with plan assets in defined contribution plans. In the FAB, the DOL, in part, stated that plans may charge the accounts of vested separated participants with the account’s share of reasonable plan expenses, without regard to whether the accounts of active participants are charged such expenses. (An article discussing all aspects of the FAB is available in our June 2003 edition.) The DOL qualified its position by stating that the FAB relates solely to the application of Title I of ERISA and that the DOL took no position as to whether any particular allocation of expenses might violate the Internal Revenue Code.

Many practitioners were, therefore, justifiably wary when the IRS indicated that its initial reaction to the FAB was that the type of allocation described might be considered to impose a “significant detriment” under Treasury Regulations section 1.411(a)–11 upon those participants who do not consent to an immediate distribution, possibly causing plan disqualification.

The IRS has now issued Revenue Ruling 2004–10, in which it officially addresses this situation. In the Ruling, the IRS determined that the allocation of administrative expenses of a defined contribution plan to the account of a former employee who does not consent to a distribution is not a significant detriment if the allocation is reasonable, and does not otherwise violate the provisions of Title I of ERISA. The IRS concluded that such an allocation “does not impose a detriment so significant as to be inconsistent with the deferral rights mandated by § 411(a)(11) because analogous fees would be imposed in the marketplace, either implicitly or explicitly, for a comparable investment outside the plan (e.g., fees charged by an investment manager for an IRA investment).”

With the DOL and the IRS now in agreement on this issue, plan sponsors may wish to review their policy on payment and allocation of plan expenses, with an eye towards recovering a portion of these expenses from former employees. Plan sponsors who may want to modify the allocation of plan expenses are welcome to discuss this issue with us in order to assure compliance with all provisions of Title I of ERISA and the Internal Revenue Code.