Companies are increasingly making divorced employees pay the processing fees related to divvying up retirement plans with their ex-spouses.

A little-known change in Labor Department policy has opened the door for imposing this cost on workers. The fees stem from the expense of processing Qualified Domestic Relations Orders (QDROs), which is required of employers to ensure the orders comply with federal tax laws.

In 1994, the Labor Department ruled that the costs of splitting up retirement benefits could be divided among all company employees. For years the department said because an employer under ERISA was responsible for processing the QDRO, no single employee should have to pay the resulting fees. As a result, employers either chose to pay the fees or divided the fees among all plan participants.

But in May 2003, the Labor Department reversed its earlier ruling and allowed companies to assess divorcing employees the QDRO processing fees.

Employers have only recently begun to implement the change, which the IRS approved from a tax standpoint in January.

Ann Moss, a Washington, D.C. attorney specializing in splitting retirement benefits, said, “Employers who use Fidelity started doing it, and Fidelity administers a lot of plans. Once they did it, I think other plan administrators saw the value of having the employee pay the fee.”

However, employers who want to charge these fees must make certain they are following Labor Department rules and complying with various provisions of ERISA, cautioned Kevin Wiggins, an ERISA management attorney with Steptoe & Johnson in Clarksburg, W. Va.

For example, the policy change applies to defined contribution plans, such as 401(k) plans, but not to defined benefit plans.

Labor Department Bulletin

The Labor Department mentioned the rule change in a field assistance bulletin that covered the allocation of expenses among participants in defined contribution plans. The bulletin was intended to respond to a variety of questions from national and regional department offices on related issues.

In the bulletin, the Department noted its earlier ruling and then went on to explicitly overturn it, stating: “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 … 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).”

The Department said that ERISA doesn’t preclude allocating to employees reasonable expenses related to a QDRO. The change also applies to Qualified Medical Child Support Orders.

The Department said any change by the employer resulting in a new fee or charge to a plan participant must be added to the summary plan description.

[The policy change is included in Field Assistance Bulletin 2003-3, which was released on May 19, 2003. You can read or print the document in the “Important Documents” section of New England In-House’s website: www.newenglandbizlawupdate.com.]

Practical Considerations

When deciding whether to charge QDRO fees to the divorcing employee, employers must consider its “compensation philosophy” and decide if it wants to use the money in the plan to pay plan expenses, said Wiggins.

“The compensation philosophy of each employer will differ,” he said. “However, it is pretty clear that by passing the QDRO fee through to the participant rather than having the employer pay the fee, the employer is making a choice to reduce the participant’s retirement benefits.”

In-house counsel must also weigh the pluses and minuses of how the employer is currently handling the payment of QDRO fees.

“If the employer has been paying the expenses and isn’t comfortable with it, they might consider passing the expense over to the individual employee,” said Ben Spater, a management lawyer in San Francisco. “If they’ve been charging everyone across the board as an expense of the plan, they may think charging the affected employee only is an equitable decision.”

Another consideration in making this decision is that an employer who chooses to pay the QDRO fees as a plan expense can take a deduction for the costs under Internal Revenue Code section 162.

“The employer must decide whether it wants to take a 162 deduction for the QDRO expenses at issue here, or whether it wants that expense to be considered a contribution subject to the limits imposed by the Internal Revenue Code,” said Wiggins.

If an employer decides it wants to use money in the plan to pay plan expenses, then it must determine if the plan permits plan assets to be used to pay plan expenses. If it doesn’t, Wiggins said the employer must amend the plan, as well as the summary plan description, to allow for the change.

Are The Fees Valid?

Employers must also make certain they are complying with the provisions of ERISA – as the fiduciary of the plan – as well as Labor Department rules, including whether the amount of the fee and the fee structure are both fair and valid under ERISA.

In practice, employers generally outsource QDROs to outside companies for processing.

The fees can range from as little as $300 all the way up to $10,000 or more, if the document has to be revised due to errors or if disputes arise over the QDRO and it has to be processed several times.

Spater said the fees become a problem when they are out of proportion to expense that goes into processing.

“I’ve seen programs which involve fairly small flat fees of $300-400, regardless of any additional work that goes into it. This is a good way to go about it, similar to a loan processing fee,” said Spater, who practices at Trucker Huss. “I’ve seen other instances where the administrators convince the plan sponsors to create a profit center out of these fees.”

Wiggins said the charges may climb even higher if the QDRO has to be processed more than once.

One of the biggest concerns is that some processing companies, such as Fidelity, charge one fee if an attorney uses their “model QDRO,” but charge a much higher fee for processing if the attorney modifies the document. According to Moss, at Fidelity the lower fee is $300 and the higher fee is $1250.

Lawyers say this “two-tier fee structure” is a serious problem because the document almost always has to be modified – which means that most divorcing employees are in effect forced to pay the higher fee.

Wiggins also said that while the “cookie cutter form” costs less, it doesn’t allow the employee’s spouse to exercise the full extent of his or her rights under ERISA.

Vista, Calif., plaintiffs’ attorney Richard Muir agreed.

“The format isn’t acceptable [to] the court here and frequently doesn’t cover things I have to have covered,” he said. “For example, a lot of times the judgment says each party is awarded half of the community property interest in order to equalize the division of benefits, and a certain amount is to be paid from the retirement benefits,” but the model QDRO from Fidelity doesn’t provide for this.

Under both ERISA and the Internal Revenue Code, spouses of divorcing employees generally have the right to defer their retirement plan distribution until age 62, Wiggins said, but “I have never seen a provider with a cookie cutter form that would permit the spouse to defer distribution under this rule.”

He argued that under ERISA, an employer has a fiduciary duty to “defray the expenses of the plan” and in passing the QDRO fees on to individual participants, the employer should ensure it is not breaching that duty by taking an unreasonably high fee.

Employers must also avoid arrangements where the QDRO processing company or outside counsel want to charge different amounts based on the actual work done in processing.

“Then it could be $500 for one person and $10,000 for another,” said Spater. “As an employer, you would be facing all sorts of battles about your contract with the provider, the [outside] lawyer’s rates – all kinds of things no one really wants to get into.”

‘Reasonable Procedures’?

Wiggins said that another provision of ERISA requires plan administrators to “establish reasonable procedures” for processing QDROs.

“The two tier fee structure – where the higher fee is not related to the services provided but has the effect of encumbering the spouse’s rights mandated by ERISA – does not comply with the requirement that a plan sponsor adopt a reasonable procedure for the administration of QDROs, and could disqualify the plan,” he argued.

Moss agreed.

“The original reason for prohibiting this is that the alternate payee has a statutory right to have those funds paid to her under a court order, and this really diminishes her right to get a QDRO payment,” she said.

Wiggins has sent a letter to the Department of Labor arguing that a two-tier fee structure is unreasonable and requesting that it rule on the issue.

Moss added that any company that requires the employee and his or her attorney to use its model QDRO is effectively violating a Department of Labor policy, which says that “plans can’t require participants and alternate payees to use model QDROs.”

Spater agreed.

“You’re forcing the consumer more than in the past to use your [preferred] model,” he said.

Muir said he hoped that the Labor Department will eventually issue a statement as to what constitutes a “reasonable” fee, though lawyers believe that’s unlikely under the current administration.

Questions or comments can be directed to the writer at [email protected].