Rev. Rul. permits allocation of expenses to former employees.

The IRS issued Rev. Rul. 2004-10, which permits a defined contribution plan to allow an employer to pay administrative expenses for active employees, while charging such expenses to terminated employees' plan accounts.

Facts

In the ruling, a defined contribution plan permits an employee to receive benefits at any time after separating from service. The plan allocates its administrative expenses among employees' accounts based on the ratio of each account balance to total account balances. Expenses not paid by the employer are charged to participants' accounts. The employer pays part of the plan's administrative expenses for active employees, but not for former employees or their beneficiaries.

Law

Sec. 411(a)(11)(A) states that if a participant's nonforfeitable benefit in a qualified plan exceeds $5,000, the plan must then provide that the benefit may not be distributed without the participant's consent. According to Regs. Sec. 1.411 (a)-11 (c)(2)(i), consent to a distribution is not valid if a plan imposes a "significant detriment" on any participant who does not consent to a distribution. Whether or not a detriment is significant is determined by the facts and circumstances.

Reasoning and Decision

According to the IRS, an allocation of administrative expenses in a defined contribution plan to the account of a participant who does not consent to a distribution is not a significant detriment, under Regs. Sec. 1.411(a)-11(c)(2)(i), as long as the allocation is reasonable and satisfies the Title I Employee Retirement Income Security Act of 1974 (ERISA) requirements (e.g., a pro-rata allocation), because, under the regulations, analogous fees would be imposed in the marketplace (either implicitly or explicitly) for a comparable investment outside a qualified plan (e.g., an investment manager's fees for an IRA investment). Thus, whether or not such expenses are charged to current employees' accounts, charging them on a pro-rata basis to the accounts of former employees is not a significant detriment imposed on an employee who does not consent to a distribution.

FAB 2003-3

The Service buttressed its conclusion by referring to Department of Labor (DOL) Employee Benefits Security Administration, Field Assistance Bulletin 2003-3 (issued 5/19/(13), which sets forth guidelines for allocating administrative expenses among plan participants in a defined contribution plan. The DOL explained that, assuming expenses are reasonable, certain administrative expenses may be properly allocated to an individual plan participant's account, and other administrative expenses may be allocated pro rata among all plan participants.

Caveats

Rev. Rul. 2004-10 contained two caveats. First, according to the IRS, not every method of allocating plan expenses is reasonable and could result in a significant detriment. For example, allocating expenses of active employees pro rata to all accounts (including those of former employees), while allocating the expenses of former employees only to their accounts, would be unreasonable, because the former employees would he bearing more than an equitable portion of the plan's expenses. Accordingly, this method would be deemed a significant detriment.

Second, the IRS stated that plan expenses must comply with the Sec. 401(a)(4) nondiscrimination rules. The expense allocation method is a plan right or feature under Regs. Sec. 1.401(a)(4)-4(e)(3)(i). The Service then gave an example of a plan that might violate the nondiscrimination rules. On the eve of a highly compensated person's divorce, a plan was amended so that expenses for determining whether a domestic relations order is qualified could be allocated pro rata, instead of to the individual's account. In this situation, the plan might fail to satisfy Regs. Sec. 1.401(a)(4)-1(b)(3) and (4) for the nondiscriminatory availability of benefits, rights and features for timing plan amendments, due to the timing of the change.

Effect on Taxpayers

Rev. Rul. 2004-10 appears to provide a tool for plan sponsors to encourage terminated employees with account balances over $5,000 to empty their defined contribution plan accounts, by charging a pro-rata share of plan administrative expenses to the former employees' accounts, while having the plan sponsor pay administrative expenses for active employees. An amendment implementing this change should be timed so that highly compensated employees are not the amendment's primary beneficiaries.

David Madden, J.D., LL.M.

Principal

Washington National Tax Service

KPMG LLP 

Washington, DC

FROM ROBERT H. MASNIK, J.D., WASHINGTON, DC