Common Problems Arising From Employee Benefit Plans
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.
For example, if a deferred compensation plan is funded for ERISA purposes, the vesting schedules that apply to tax-qualified plans will apply.
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).
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.
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)
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)
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)
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)
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.
Protection Limits. The protection provided by this exemption is limited in the following respects:
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.
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.
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. 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).
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.