Most business owners are seeking ways to reduce the costs of operations, and benefits are prime targets for cost cutting, partly as a defense to anticipated increases in health care for 2010.

With retirement benefits, the trend is for administrative costs to remain level due to competition among providers. Thus, the only meaningful cost reductions are to shift employer costs to the plan. Strategies for increasing the fees participants pay indirectly through the plan seem simple but can sometimes be complicated to implement. One element in this cost shifting, unlike  transferring some health benefit costs to employees, is that it will not directly affect the participant’s paycheck. However, any decision to pay fees out of the plan is a fiduciary decision that must not violate ERISA.

Assuming that your plan’s service providers are competitive, you have only two ways to reduce an employer’s 401(k) costs: (1) reduce the level of employer contributions being allocated, and/or (2) have the plan pay for the plan’s administrative services for which the employer is paying. Our focus will be on implementing the latter.

The place to start is the rules under ERISA. Plans and participants are permitted to pay for certain costs of plan administration that benefit the participants, including investment management, recordkeeping, processing benefits, governmental reporting, participant disclosures, and the cost of an IRS determination letter. Three rules apply: (1) the plan document must permit the payment by the plan (or at least not prohibit the payment), (2) fees paid must be reasonable when considered with other payments to a service provider, and (3) certain expenses that are the inherent responsibility of the employer—so-called “settlor’s” costs—cannot be paid by a plan, either directly or indirectly.

DOL Advisory Opinion 2001-01A made these rules quite clear. That guidance adds that when a fee covers a plan service that is beneficial to both the employer and the plan participants, the costs should be split between the two parties. However, if the employer benefits only incidentally, then the plan may pay the full cost. Fees for certain services related to that termination such as a plan audit, filing of final governmental reports, and notifying participants and beneficiaries can be paid by the plan. On the other hand, the cost of a plan termination is a settlor function and must be paid by the employer, at least with respect to expenses incurred in making the decision to terminate the plan.

DOL guidance on a plan’s payment for services such as a plan redesign is less clear and needs to be carefully considered. The cost of plan redesign tends to be a settlor cost when the change relates to the employer’s business activities. Amending a plan to stay current with law changes is not a settlor function. Unfortunately, the DOL has not issued further guidance on this issue. The 2001 Advisory Opinion did confirm that the decision to pay any expense out of the plan’s assets is a fiduciary decision.

Once the decision is to have the plan pay for certain services, the next question is how to do it. That is, in most plans there is no way to have the 401(k) plan write a check. Moreover, if it could, the allocation of that payment to the participants is necessary. The expense could also be paid from forfeitures. However, if forfeitures are used to reduce the employer’s match, that does not reduce the employer’s expenses. In addition, many of the plan’s services are provided in a manner that may not allow for easy allocation to the affected plan participants. For example, if the cost to prepare the compliance testing and governmental reporting for a 401(k) plan is $2,000 and there are 38 active and two terminated participants, how is the amount to be apportioned? Is it reasonable to charge each participant account a flat $50 fee, including a new participant who only contributes $200? If your answer is yes, when is that payment charged to the accounts, and what if the fee or number of participants change? What do you do about the overage or underpayment? One thing you cannot do is reimburse the employer for a fee it pays to a provider.

Many employers may be reluctant to impose a flat fee to each participant’s account because it impacts the small accounts more dramatically than larger accounts. It is also out in the open for participants to see and question. As a result, most employers would rather impose the charge on a pro rata basis as a small percentage of the plan’s assets. How the plan does this will depend on the way in which the plan’s assets are held. The answer may vary depending on whether the plan’s investments are part of a group insurance contract, trust account, open architecture, or program sponsored by a mutual fund company.

With a group insurance product, the contract’s wrap fee or its internal charges frequently can be increased to pay a service provider. This is typically done with a contract change. The same may apply to a trust account. However, not all contracts have this flexibility. With a program from a mutual fund company, you may have to change share classes to arrange this type of payment. That can require a full liquidation of the plan’s assets. With open  architecture, the record keeper may need to offer a different class of shares or liquidate a small percentage of plan assets periodically to accumulate the funds to pay a provider. Many of these funding programs now have options for accumulating these account charges and holding them in an account to either pay to a provider or reallocate to participants if not used each year.

In addition to flat fees on a per capita basis or charging a percentage of assets, the employer may add a per use charge, which would charge participants for their loans, distributions, and hardship distributions. The fee to the participant must be reasonable for the services received and follow the guidelines described above.

“Reasonableness” is a more complex determination if a plan fiduciary wishes to impose a fee on the accounts of terminated participants who have declined a plan distribution. These fees are permitted when the employer wants to pay the administrative costs for active employees
only. The account charge should reflect the employer’s cost of plan administration. When the plan is already paying for all plan administration fees, an additional charge to a terminated employee is not acceptable. The IRS has also raised discrimination issues that could affect a plan’s tax qualification if there is discrimination against nonhighly compensated employee participants.

The IRS held a hearing on the proposed safe harbor regulations in late September. The witnesses urged the IRS to remove one requirement that employers permit to revoke or suspend the non-elective 3% contribution to a safe harbor 401(k) plan design. That requirement conditions the suspension on the employer establishing a “substantial business hardship.”

Proposed reliance regulations issued last May included this requirement and stated that the hardship definition is comparable to the requirements of IRC § 412(c), relating to waivers of annual funding requirements for pension plans.  Interestingly, existing regulations regarding the suspension of safe harbor matching contributions do not include this condition. That fact was not missed by those at the hearing.

Representatives of the American Benefits Council and the American Society of Pension Professionals and Actuaries argued that the ability to suspend these contributions should not be limited to extreme circumstances.  In addition, they argued that employers who are struggling financially, but cannot meet the definition of substantial business hardship, should be encouraged to keep the plan in place rather than to terminate the plan to end the commitment to make these contributions.

These witnesses also objected to the content of the notice that the proposal requires employers to provide to plan participants regarding the reduction or suspension of these contributions.  They felt that the requirements added to the length of the notice but did little to help employees.  In fact, they argued that the additional content could actually confuse employees and obscure the meaning of the notice.

Sometime twice as much is not better than once. That was the result in a recent District Court decision Young v. Verizon’s Bell Atlantic Cash Balance Plan, (N.D. Ill. Nov. 2, 2009). The court’s decision resulted from a class action brought by long-term employees of Verizon’s predecessor companies. Participants in the plans of those companies became participants in a Verizon cash balance plan established January 1, 1996. Basically, the court agreed with an attempt by Verizon to have a provision of the cash balance plan impacting benefit calculations be disregarded because of a scrivener’s error.

The provision impacted a key aspect of the transition to the cash balance plan that was the calculation of the participants’ opening balances. A portion of the document used a transition factor to increase the calculated value of participants’ balances.  Unfortunately, the attorney who drafted the relevant plan provision included two references to use of the transition factor in the sentence describing this aspect of the calculations.  No one noticed this duplication before final approval of the plan document.  All of the voluminous disclosure materials furnished to participants referred to use of the transition factor only once, not twice.

Using the transition factor twice would have increased the opening balances of 10,808 affected participants by $1.67 billion.  Nevertheless, the plaintiffs argued that Verizon had to adhere to the plan terms and use the transition factor twice.  The court concluded that there was “clear and convincing evidence that a scrivener’s error and mistake were made” in the preparation of the plan document with two references to the transition factor.  It noted that the mistake occurred and the plan document was finalized after all of the opening balance calculations were completed.

The court viewed this issue as “novel” and permitted reformation of the plan document as appropriate equitable relief under ERISA.  The alternative would be to provide the plaintiffs with a benefits windfall.  An earlier decision ruled the plan language was unambiguous and could not be reformed by the plan’s administrative committee but could only be revised for scrivener’s error by a court. Young v. Verizon's Bell Atlantic Cash Balance Plan, No. 05 C 7314, 2008 WL 4066517 (N.D. Ill.  8/28/08).

According to press reports, the new EBSA head, Phyllis Borzi, proclaimed that there is “a new sheriff in town” in remarks at the DOL Speaks conference sponsored by ASPPA on September 14, 2009 in Washington, D.C.  She asserted that the previous administration had focused on “compliance assistance,” but that only works “if it is combined with strong enforcement.”

One of her key enforcement programs will be a “contributory plan criminal project” to initiate criminal prosecutions of plan fiduciaries who embezzle plan funds, including those who fail to send in employee deferrals to 401(k) plans.  This program will target “the most egregious and persistent violations” to protect vulnerable employees.  Another target will be plan sponsors who knowingly file false Form 5500s.  These efforts will focus on individuals involved in these activities as well as the related businesses.  As an example of its current activity, EBSA posted data on its website showing that in Fiscal Year 2008, its enforcement activity resulted in 101 indictments of plan officials, corporate officers, and service providers, along with significant other enforcement activity.  [http://www.dol.gov/ebsa/newsroom/fsFY08results.html]

She also described the establishment of a rapid ERISA action team (“REACT”) to protect plan participants who are at greatest risk, such as employees whose employers are in bankruptcy.  This team will focus on ensuring that those employees receive what is legally required.  EBSA also has a consultant advisor project that focuses on “improper, undisclosed compensation to plan advisors.”  This is being expanded to cover situations where service providers use their fiduciary status to increase their compensation.

As to regulatory matters, Ms. Borzi stated that the first priority is to issue new regulations regarding investment advice, which should occur in November.  EBSA will also issue two sets of rules regarding plan fees and expenses, probably in early 2010.  She indicated that plan fees should be “transparent” and that disclosures should permit “apples-to-apples” comparisons.  Decisions regarding target date funds should occur by the end of 2009.  The goal is to improve participant understanding of how these funds operate.