When an employee leaves a small company, the expectation is that he will withdraw his 401(k) money at the same time. While former employees of larger companies often leave their 401(k) money in the plan until retirement, small companies have less tolerance for this since they don’t have large benefit departments or contract administrators equipped to keep track of and assist employees from long ago.
If an employee chooses not to withdraw his 401(k) money when leaving a small firm, the employer might be tempted to stick that person with a fat “account maintenance fee” as an enticement for that person to take his money and move on. Can they do that? Is such a fee legal?
Plan May Not Impose “Significant Detriment” to Leaving Money Behind
Under the law, participants generally have to voluntarily consent to retirement plan distributions. You can’t pay someone out unless he’s signed a form saying he wants his money. The Treasury Regulations say that consent is not valid if a significant detriment is imposed on any participant who doesn’t consent to the distribution (i.e., wants to leave his money in the plan). The idea is that if you make it hard for someone to keep their money in the plan, the consent to withdraw the money is not truly voluntary.
So, what is “significant detriment?” The regulation says it shall be based on the “facts and circumstances.” This is another way of saying we’ll know a problem when we see it. Fortunately, we have some guidance from various IRS and DOL rulings and announcements. Among other things, significant detriment means you cannot give a terminated participant a limited range of investment options while giving active employees a much broader range of investments. You also cannot make a former employee who has chosen not to take his money wait an unduly long time before having another chance at a withdrawal.
Fees Must Be Reasonable and Proper
Regarding assessing fees to terminated employees, the general rule is that you may do so provided the fee is reasonable and the expense is something that is properly payable by the plan anyway. This is best explained with a few examples:
- The recordkeeper charges the plan sponsor an annual per-participant fee. The fee is reasonable and is allowed to be paid by the plan. If the employer wanted to pay this charge from company funds for active employees but have the fee come from the plan accounts of terminated participants, that is fine.
- The investment advisor charges a percentage of assets each quarter for its services. The charge is spread pro-rata among the participants; those with large account balances pay more than those with small accounts. Here, too, the employer could choose to pay the investment advisory fee for all active participants and let the charge for terminees come out of their account balances, assuming the fee is reasonable.
- An accountant’s audit is required each year for the Form 5500. Normally, the employer pays the fee for this service. One year, it decides to assign to each participant a portion of this cost based on the size of the accounts. The employer continues to pay the share of this fee assigned to active employees. The portion of the fee assigned to terminated participants comes from the terminee’s plan account. This is permissible since this is an expense that may properly be paid by the plan.
- The employer charges an account maintenance fee that applies only to terminated employees. This fee is not associated with any service performed for the plan. It’s just a way of encouraging former employees to move their money out of the plan. Such a fee does not appear to be permissible.
In the third example above, the audit fee has been allocated pro-rata based on account balances. An alternative would be to allocate the fee “per capita” – an equal dollar amount for all participants. There is no rule against this, but the DOL advises “prudence” so that people with small account balances do not bear a disproportionate share of the fee. Charging each participant $200 toward the audit would hurt someone with a $1,000 account balance a lot worse than it would someone with $1 million. This would not fly.
The plan’s legal document may have rules concerning plan expenses. These must be followed. Where the plan document is silent or ambiguous, the plan sponsor must select the method for allocating expenses. We are happy to help plan sponsors determine what can and cannot be done in this area.