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I believe under the circumstances that you describe that the child MUST be allowed to participate in the plan.

What does the Fiduciary Plan Administrator want you to do? A QDRO alternate would also qualify as a participant/beneficiary under the plan so there is a fiduciary duty to the alternate too. What happens if the QDRO requires that 100% of the proceeds be paid to the alternate and you paid out the hardship to the particpant? Also, is the participant trying to get money out the plan to avoid paying it to her spouse? Is there a property settlement agreement or divorce order that specifies what the alternate will be getting? If so, then you know for sure that the Plan Administator will have a fiduciary duty to the alternate too.

Id say it is the opposite. The 1099-R reflects the distribution, which is $10,000. The fee is just that, a fee, not a distribution, so why would you need to gross up what you are asking for? The fact that the fee is charged because of the distribution doesn't make it part of the distribution.