Common Problems Arising From Employee Benefit Plans

Critical Issues in Employee Benefits

University of South Florida

Fall 1999

William D. Mitchell

Mitchell Law Group

Tampa, Florida 33602

(813) 223-1959

Materials herein are composite of materials
from Canan & Mitchell, Employee Fringe and
Welfare Benefit Plans, (West Publishing 1998 ed.);
Mitchell, Estate and Retirement Planning Answer
Book (Panel Publishers 1999), and from internal
materials from Mitchell Law Group.

The following are some of the essential aspects of benefit plans administration that are commonly overlooked by employers. An auditor that finds these problems can save a client large amounts of money.

  1. Failure to recognize the importance of the summary plan description. In Florida, the summary plan description is the primary document for interpreting a person's rights under the plan. It controls over the plan document, unless the plan document is more favorable to the participant. See Alday v. Container Corp. of America, 906 F.2d 660, 665-66 (11th Cir. 1990), cert. denied, 498 U.S. 1026, 111 S.Ct. 675, 112 L.Ed.2d 668 (1991) (oral or written communications external to the summary plan description are inapposite when summary plan description is clear); McKnight v. Southern Life & Health Ins. Co., 758 F.2d 1566, 1570 (11th Cir. 1985)(summary plan description controls over inconsistent plan document).

  2. Failure to recognize the pervasiveness of the ERISA requirements. ERISA does not just apply to tax qualified plans but may also apply to plans such as severance plans and nonqualified deferred compensation plans. In some cases stringent vesting and distribution rules may apply.

    For example, if a deferred compensation plan is funded for ERISA purposes, the vesting schedules that apply to tax-qualified plans will apply.

  3. Failure to Have Appropriate Standard of Review Language

    1. Introduction. " Standard of review" refers to the degree of scrutiny that is given administrative decisions on plan benefits. The range of scrutiny can vary from de novo review, in which a court reviews the decisions of the plan administrator on the basis of all the evidence before it, to review for abuse of discretion (or "arbitrary and capricious" standard of review) in which the court determines whether the administrator's decision had a rational basis. In Firestone Tire and Rubber Co. v. Bruch, 489 U.S. 101, 109 S.Ct. 948, 103 L.Ed.2d 80 (1989), the Supreme Court held that decisions to deny benefits on the basis of plan interpretations are reviewed not under the arbitrary and capricious standard but under the de novo standard of review unless the plan gives the administrator or fiduciary discretionary authority to determine eligibility for benefits or to construe the terms of the plan. The Supreme Court concluded that, "where discretion is conferred upon the trustee with respect to the exercise of a power, its exercise is not subject to control by the court except to prevent an abuse by the trustee of his discretion."

      In the wake of Firestone, the Eleventh Circuit has taken the position that a range of standards of review pertain to benefits determinations under ERISA. These standards of review are: (1) de novo, applicable where the plan administrator is not afforded discretion, (2) arbitrary and capricious when the plan grants the administrator discretion, and (3) heightened arbitrary and capricious where there is a conflict of interest. Buckley v. Metropolitan Life, 115 F.3d 936, 939 (11th Cir.), rehearing denied, 129 F.3d 617 (11th Cir. 1997). These standards of review apply equally to the decisions of plan fiduciaries and the plan administrator. Brown v. Blue Cross & Blue Shield of Ala., 898 F.2d 1556, 1560 (11th Cir. 1990).

    2. Magic Language. The Eleventh Circuit, consistent with other United States Courts of Appeals, has held that a denial of benefits under an ERISA plan with language that gives the plan administrator discretionary authority to determine eligibility for benefits or to construe the terms of the plan is reviewed by the district court for abuse of that discretion. Shannon v. Jack Eckerd Corp., 113 F.3d 208, 210 (11th Cir.1997).

      Example: The Administrator shall have the exclusive discretion to determine eligibility for benefits and the amount of benefits payable, both initially and on review, to construe the terms of the Plan, and to make factual determinations. Any decision by the Administrator shall be final and binding on all parties.

    3. Review of Factual Determinations. The Eleventh Circuit has recently held that if an ERISA plan grants discretion to a plan administrator to interpret the express terms of the plan or to determine eligibility for benefits, both the administrator's construction of the plan and the related factual findings are reviewed under an arbitrary and capricious standard of review . These findings will be upheld if reasonably based on the information known to the administrator at the time the decision was rendered. Paramore v. Delta Air Lines, Inc., 129 F.3d 1446 (11th Cir. 1997). The Paramore decision provides employers with an additional incentive to adopt plans that clearly give discretionary authority to the plan administrator to determine eligibility for benefits.

    4. Improper Delegation of Authority. One court has held that a less deferential standard of review applies when a plan administrator improperly delegates its fiduciary decision making authority to another party. Doe v. Travelers Ins. Co., 971 F.Supp.623, 635 (D.Mass. 1997).

  4. Individual Named as Plan Administrator. Employee benefit plans often provide that corporate officials are the plan administrator. This can be dangerous for the official because of the penalties that are specifically imposed on the plan administrator for either a failure to file Form 5500s or for a failure to respond to a request for plan documents.

    1. Form 5500s. Severe sanctions may result from the failure to file a timely and accurate annual report (Form 5500). The Secretary of Labor may assess a civil penalty of up to $1,000 per day for failures to file Forms 5500. ERISA 502(c)(2), 29 USCA 1132(c)(2).

      The Department of Labor has issued proposed regulations that set forth the process for assessing penalties. The first step is written notice from the Department of Labor to the plan administrator expressing an intention to assess the penalty, the amount of the penalty, the period for which the penalty applies, and the reasons for it. The plan administrator can respond by making a written affirmative showing that reasonable cause exists for his not filing the Form 5500. This must be filed within 30 days following receipt of the notice from the Department of Labor. A failure to file this affirmative showing of reasonable cause results in a waiver of the right to appear and contest the facts received in the notice. If the plan administrator does make a showing that reasonable cause exists, the Department of Labor may seek a hearing before an administrative law judge.

      The Secretary of Labor can reject a filed annual report if he determines that the report is incomplete or contains a material qualification by an accountant or actuary. ERISA 104(a)(4), 29 USCA 1024(a)(4). Such reports are treated as not filed. If an annual report is rejected, the administrator has 45 days to submit a revised filing that is satisfactory to the Secretary of Labor. If this is not done, the Secretary can take a variety of actions, including retaining a public accountant to audit the plan or bringing a civil action for appropriate legal or equitable relief.

      Criminal Sanctions. ERISA imposes criminal penalties for making false statements and concealing facts in documents that are required to be kept by ERISA. 18 USCA 1027. This statute has been applied to plan participants,(1) employers(2)and plan fiduciaries.(3)

    2. Failure to Provide Plan Documents. A plan administrator who fails to comply with a participant's or beneficiary's request for information may be subject to a $100 per day penalty under ERISA 502, 29 USCA 1132. For purposes of enforcing this statute, the term "participant" includes more than active employees who are covered by the plan in question. The term includes employees who are covered by the plan or who reasonably can expect to be covered by the plan or former employees who have a reasonable expectation of returning to covered employment or who have a colorable claim to vested benefits. Former employees who have neither a reasonable expectation of returning to covered employment nor a colorable claim to vested benefits are not participants who can sue to enforce this statutory provision.(4)

  5. Failure to retain plan documents. Often plan documents are lost or misplaced, particularly summary plan descriptions, even though they are the primary litigation document in Florida. One health plan may have lost an $400,000 lawsuit because it did not keep an old trust document. Ideally plan documents will be kept for the employment period of the most senior employee other than the owner or for ten years, whichever is greater. Sometimes it is not practicable to keep documents that long. Important cutoff points (in the sense that the amount of protection increases significantly when those thresholds are crossed) are four years and seven years.

  6. Failure to follow plan documents. ERISA provides that plan administrators have a fiduciary duty to follow plan documents to the extent that these documents are consistent with Title I of ERISA. The courts, by and large, enforce plan documents as written. This problem usually occurs in the context of a splitting up of a practice or company when emotional factors come into play and the remaining owners believe that it is equitable to hold a participant's plan assets hostage. If extraneous provisions are found in a plan document, an ERISA violation may be found that otherwise would not exist or would be difficult to prove. For example, the Fifth Circuit has affirmed that an ERISA violation existed when an insurance agent induced an ERISA plan to purchase individual whole life insurance policies in violation of the terms of the plan document which required that group life insurance be purchased. Reich v. Lancaster, 55 F.3d 1034 (5th Cir.1995).

  7. Failure to execute documents. A surprising number of employers fail to execute plan documents or to properly adopt them. For example, a plan may be adopted by action of the President of the Corporation when it should be adopted by the Board of Directors of the Corporation in the absence of a valid delegation of authority.

  8. Use of welfare benefit plans to provide retirement benefits. These plans are benefit programs that provide severance benefits and death benefits. They are designed to work like a tax-qualified plan in the sense that employers are expected to take immediate deductions for contributions to the plan and that participants do not expect to be taxed until distributions are made. They differ from tax qualified plans in that the discrimination requirements for tax-qualified plans would not apply to them. In Booth v. Commissioner of Internal Revenue, 108 T.C. 524 (1997), the Tax Court partially sustained an IRS challenge to the Prime Plan by holding that amounts contributed to the plan by the employers were deductible only within very narrow limits. For the tax years in question, the Tax Court allowed a deduction for only $11 out of claimed deductions of several hundred thousand dollars. The Tax Court also held that because the "Prime Plan" was a welfare benefit plan, the taxpayers were not immediately taxable on the amounts contributed to it, which was a victory for the taxpayer. The IRS has issued a public notice stating that it intends to attack these plans on a variety of grounds (Notice 95-34) and we have been told by the IRS that the IRS has several cases pending against these plans in Tampa.

  9. Severance Plans. These plans too often are drafted in an informal manner and are ambiguous. This only invites litigation. Further, employers often fail to recognize that severance plans are covered by Title I of ERISA. This means that the standard of review language described above should be included in the plan document.

  10. Disability Plans. Assuming a document even exists, these plans often fail to specify whether disability is determined by the social security definition (unable to engage in any employment) or whether disability exists if the participant is unable to engage in his or her customary employment. The existence of a written plan document is not necessary for the courts to infer the existence of a disability plan covered by ERISA.

  11. Top Hat Plans: Failure to provide notice. Top hat plans that provide deferred compensation, as opposed to welfare benefits, are subject to reporting requirements under ERISA. They can satisfy these requirements by providing plan documents to the Secretary of Labor on request and by filing a statement with the Department of Labor that includes the employer's name and address, its employer identification number, a declaration that the plan is maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees, and a statement of the number of such plans and the number of employees in each.(5)

    This statement must be filed within 120 days after the plan becomes effective. A failure to comply with these minimal regulatory requirements can subject the top hat plan to the full reporting and disclosure requirements of Title I of ERISA, including for example, the accounting provisions of ERISA 105(a).(6)

    Moreover, the Department of Labor has asserted that if the statement is not filed within the 120 day period, the plan administrator must file an annual report every year. Because substantial civil penalties that can be imposed for failing to file an annual report, plan administrators who completely ignore this requirement are potentially at great risk.

    Top Hat Plans. Top hat plans are unfunded deferred compensation plans maintained by employers primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.(7)

    Sketchy guidance as to what constitutes a select group of management or highly compensated employees is provided by some Department of Labor advisory opinions and by case law.(8)

    The Department of Labor has also stated that the term "primarily" refers to the purpose of the plan (i.e. the type of benefits provided) and not to the participant composition of the plan.(9)

    This implies that a top hat plan can provide benefits other than deferred compensation so long as the primary purpose of the plan is to provide deferred compensation coverage. It suggests, however, that a top hat plan cannot cover employees other than those in the select group.(10)

  12. Failure to consider whether plan funded under ERISA. Funded status for Title I purposes can have serious consequences under ERISA. Funded status can impose substantial reporting and disclosure requirements on nonqualified plans, and more importantly, restrict the plan itself as to participation, vesting, and funding, much like qualified plans. Because of these restrictions, nonqualified deferred compensation plans are often designed to avoid or minimize the impact of ERISA. One plan that is often used to achieve this objective is an unfunded top hat plan. The difficulty is that sometimes plan sponsors risk funded status for top hat plans by not being aware of the broad definition adopted by the Department of Labor.

    Funded Status. It has been held that a plan was unfunded for purposes of Title I of ERISA when the employer specifically reserved the right to treat an insurance policy as one of its general assets and when the employer was not required by the plan to acquire assets to finance the liabilities created by the plan.(11)

    The Department of Labor has stated that insurance would not cause a plan to be funded if: (1) the insurance proceeds were payable only to the employer; (2) the employer had all rights of ownership under the policy; (3) neither the participants nor the beneficiaries had any preferred claim against the policies or any beneficial ownership interest in the policies; (4) no representations were made to participants or beneficiaries that policies would be used to provide benefits or were security for benefits; (5) plan benefits were not limited or governed in any way by life insurance policies; and (6) the plan did not permit employee contributions.(12)

  13. Failure to file annual reports. A Form 5500 is filed for plans with 100 or more participants at the beginning of the plan year; the form must be accompanied by an audit report unless the plan is fully funded with insurance, unfunded, or a combination of the two.(13)

    For plans with fewer than 100 participants at the beginning of the plan year, a Form 5500-C is filed for the first plan year, the year in which the final annual report is due and for any year in which a Form 5500-R is not filed. A Form 5500-R may be filed for a plan with fewer than 100 participants at the beginning of the plan year if the plan year is not the first plan year, if the plan year is not a plan year in which a final report return is due, and if a Form 5500-C has been filed for one of the two prior plan years.(14)

  14. Failure to adequately consider the use of a tax qualified plan. As a result of restrictive legislation passed by Congress over the past 15 years, tax-qualified plans have lost some of their luster. However, these plans have important attributes that make them worthy of serious consideration. They are often underutilized. The attributes are:

    Tax Deferred Accumulation of Earnings. Earnings on amounts invested in tax-qualified plans are not subject to income tax until the earnings are distributed. Over a long period of time this favorable tax treatment can make a substantial difference.

    Current Deduction when Contributions Made. Contributions to tax-qualified plans (within certain limits) are deductible when made, but they are not taxable to participants until distributions are made.

    Individual Control of Investments. Although fiduciary restraints exist, tax-qualified plans can invest in land, hold partnership interests, and invest in personal notes.

    Possible Improved Regulatory Environment. Senator Graham and some administration officials have become concerned that existing retirement vehicles are inadequate to meet what appears to be the pending retirement crisis. Congress has taken some steps towards simplification. For example, filing requirements for Summary Plan Descriptions and Summary of Material Modifications have been eliminated.

    Age\Weighted and Cross Tested Plans. These methods provide additional ways to focus benefits on key employees. If the key people are significantly older than the remainder of the work force, almost all benefits can be allocated to them.

    Defined Benefit Pension Plan. Because of the administrative expense associated with these plans many employers are inclined to reject them. But in the correct circumstances they can provide significant benefits to key employees.

    Asset Protection. Tax qualified plan assets are protected against judgment creditors. This protection generally exists even if the participant goes into bankruptcy.

  15. Misunderstanding of the protection afforded by ERISA 404(c). Plans providing for employee direction of investments have become very popular, in part, because a correctly designed plan may limit an employer's fiduciary responsibility. The statutory provision that provides this protection is ERISA 404(c). This provision largely insulates employers and plan officials from investment mistakes but it does not provide total protection from fiduciary liability.

    Protection Limits. The protection provided by this exemption is limited in the following respects:

    1. It does not protect against the tax imposed on disqualified persons for engaging in a prohibited transaction under the Tax Code.

    2. Fiduciaries are not insulated from liability resulting from instructions that:

      Are not in accordance with plan documents and instruments.

      Cause a fiduciary to maintain the indicia of ownership of any plan assets outside of the jurisdiction of U.S. district courts.

      Jeopardize the plan's status as a tax-qualified plan.

      Could result in a loss in excess of the participant's account balance.

      Result in a direct or indirect exchange or lease of property between the plan sponsor (or any of its affiliates as defined in the regulations, including, among others, officers, employees, and directors of the employer) and the plan.

      Result in a direct or indirect loan to a plan sponsor (or any affiliate of the sponsor as defined in the regulations) or the acquisition, sale, or lease of any employer real property or (with certain exceptions) securities.

    3. Fiduciaries are not protected where losses are attributable to intervening breaches of fiduciary responsibility as opposed to breaches caused by the investment instructions. [Lab Reg 2550.404(c)-1].

      Example: A participant instructs a plan fiduciary to invest in a certain stock. The plan fiduciary is unreasonably slow in executing the instructions, which results in a loss. The plan fiduciary would not be insulated from liability by the investment direction statute and regulations.

      Example: A participant chooses an investment manager pursuant to the investment direction provisions. The investment manager makes imprudent investments. The investment manager is not relieved of liability, because the imprudent investments were not the result of the participant's exercise of control. The only control the participant exercised was to choose an investment manager. Had the participant directed the investment manager to make an investment that turned out be imprudent, the manager would be relieved of liability. [Lab Reg 2550.404c-1(f)(3)].

      Some commentators believe that these regulations should be read to imply that the array of funds that is available for investment be selected prudently. Prudence in this context means making a reasonable examination of the fund's investment performance on a periodic basis (at least once a year). As a practical matter it may preclude an employer from providing investment alternatives in more than six or seven funds. In any event, the regulations clearly provide that plan fiduciaries are responsible for any losses resulting from an imprudent participant investment decision that causes the plan to incur losses in excess of the amount in a participant's account.

      Example: A plan permits unlimited investment discretion. A participant invests in a general partnership that goes into bankruptcy causing the plan to assume partnership obligations in excess of the participants account. The plan fiduciary is liable for the losses to the plan in excess of the account balance.

    4. Default Accounts. Plan fiduciaries, not the participants in the plan, are responsible for the investment performance of funds placed in a default account, that is to say ERISA 404(c) protection does not exist for default accounts. Accordingly, it is probably a mistake to have the default account invested in very conservative investments such as money market accounts, which many employers do.

    5. Failure to monitor investment options. Plan sponsors probably have a fiduciary duty to monitor the investment options that are available to plan participants and eliminate those that are substandard. One criteria of substandard performance is 3% below the peer group for a period of three years.

      Threshold requirements. The following threshold requirements, which according to Department of Labor regulations must be met to obtain the protection available under ERISA 404(c), are often not met. The failure to follow these requirements may destroy the use of ERISA 404(c) as a defense.

    1. Failure to designate a fiduciary responsible for carrying out a participant's instructions and providing the specified investment information to plan participants. The fiduciary may delegate those duties.

    2. Failure to provide statement that employer intends that plan comply with ERISA 404(c).

    3. Failure to tell participants that they have the right to obtain written confirmation of every investment change they make.

    4. If company stock is an investment option participants must be given a description of the procedures for maintaining the confidentiality of the purchase, holding, and sale of company stock.

  16. Failure to consider loads charged on 401(k) and other investment vehicles. The Department of Labor looked into the question of whether excessive loads are being charged by investment advisors for 401(k) plans. If these loads are paid out of employee salary reduction contributions there is clearly a fiduciary duty on the part of the plan sponsor to ensure that the loads are reasonable.


1. United States v. Bartkus, 816 F.2d 255 (6th Cir.1987), cert. denied 484 U.S. 842, 108 S.Ct. 132, 98 L.Ed.2d 90 (1987).

2. United States v. S & Vee Cartage Co., 704 F.2d 914 (6th Cir.1983), cert. denied 464 U.S. 935, 104 S.Ct. 343, 78 L.Ed.2d 310 (1983).

3. Id.

4. Firestone Tire and Rubber Company v. Bruch, 489 U.S. 101, 109 S.Ct. 948, 103 L.Ed.2d 80 (1989).

5. Labor Reg. 2520.104-23.

6. Barrowclough v. Kidder, Peabody & Co., 752 F.2d 923 (3d Cir.1985).

7. ERISA 201(2), 29 USCA 1051(2); ERISA 301(a)(2), 29 USCA 1081(a)(2), and ERISA 401(a)(1), 29 USCA 1101(a)(1).

8. DOL Adv.Ops. 75-63 (unfunded plan for salaried employees earning at least $18,200 and classified as key employees was top hat plan), 75-64 (unfunded plan limited to most highly compensated 4% of employees whose annual compensation was $28,000 compared to $19,000 average compensation for all employees was top hat plan), 75-48 (unfunded plan limited to 23 of 14,000 employees with salaries ranging from $19,286 to $67,992). Compare DOL Adv.Op. 76-100 (plan open to all employees with three years of service was not top hat plan). However, these letters are now over ten years old and a substantially more restrictive definition would probably be forthcoming if new guidance were issued. And see Belsky v. First National Life Insurance Company, 818 F.2d 661 (8th Cir.1987), Belka v. Rowe Furniture Corp., 571 F.Supp. 1249 (D.Md.1983); Darden v. Nationwide Mutual Insurance Company, 717 F.Supp. 388 E.D.N.C.1989), affirmed on other grounds 922 F.2d 203 (4th Cir.1991), cert. granted 502 U.S. 905, 112 S.Ct. 294, 116 L.Ed.2d 239 (1991) (18% of workforce not select group when participants' income comparable to that of remainder of workforce); Gallione v. Flaherty, 70 F.3d 724 (2d Cir. 1995) (covered group of union officers considered select when only 22 of 68 were entitled to participate in plan).

9. DOL Op.Ltr. 90-14A.

10. Compare Belka v. Rowe Furniture Corp., 571 F.Supp. 1249 (D.Md.1983) (some non-select group employees may be included in top-hat plan).

11. Belsky v. First National Life Insurance, 818 F.2d 661, 663 (8th Cir.1987). The Department of Labor has stated that a plan is not unfunded if there is a separately maintained bank account or other evidence of the existence of a segregated or separately maintained or administered fund out of which plan benefits are to be administered. See also Belka v. Rowe Furniture Corp., 571 F.Supp. 1249 (D.Md.1983), Dependahl v. Falstaff Brewing Corp., 653 F.2d 1208 (8th Cir.1981), cert. denied 454 U.S. 968, 102 S.Ct. 512, 70 L.Ed.2d 384 (1981). Northwestern Mutual Life Insurance Company v. Resolution Trust Corporation, 848 F.Supp. 1515 (N.D.Ala.1994).

See also DOL Op. Ltr. 92-13A (plan funded by rabbi trust holding employer stock is unfunded for ERISA purposes); DOL Op. Ltr. 91-16A (plan funded by model rabbi trust is unfunded); DOL Op. Ltr. 89-24A (plan funded by life insurance held in grantor trust is unfunded, and voluntary loan provisions allowing employees to loan their distributions to the employer will not violate ERISA).

12. DOL Adv.Op. 81-11A.

13. The AICPA has issued a guide, Audits of Employee Benefit Plan, effective for audits for plan years beginning after December 15, 1990.

14. 1988 Instructions to Form 5500, p. 4.