401(k) Benefits May be Real Liabilities

And By: Samson R. Elsbernd
401(k) retirement savings plans and similar defined contribution plans generally shift retirement plan risks from employers to employees. However, a recent Supreme Court Case decided this past February, LaRue v. DeWolff, Boberg & Associates, could make 401(k) defined contribution plans riskier for employers.

Defined Benefit Plans v. Defined Contribution Plans
Employers generally offer employees one of two types of retirement plans: defined benefit plans or defined contribution plans. Defined benefit plans provide a set retirement income, which is usually related to the number of years worked and employee compensation. On the other hand, defined contribution plans, also called individual account plans, provide payment according to the individual employee’s retirement account, which depends upon the amounts contributed and the performance of that account. 401(k) retirement savings plans are popular defined contribution plans.

Previously, the Supreme Court, in Massachusetts Mutual Life Insurance Company v. Russell, ruled that an employee could not sue the fiduciary of her plan (her employer) under ERISA (Employee Retirement Income Security Act of 1974) for breach of fiduciary duty concerning a defined benefit retirement plan. However, the Supreme Court recently allowed an employee to sue his employer under ERISA for fiduciary breach concerning his defined contribution plan.

Employees Can Sue Their Employers Regarding Their 401(K) Plans

In LaRue v. DeWolff, Boberg & Associates, the United States Supreme Court clarified that ERISA authorizes individuals to sue and recover for fiduciary breaches that impair the value of the retirement plan assets in the employee’s individual account. LaRue, the employee, sued his employer regarding his 401(k) retirement plan. His plan provided procedures and requirements that enabled individual plan participants to direct the investment of their contributions. LaRue alleged that he directed his employer to make investment changes in his individual account that the employer did not make. Consequently, he claimed his individual retirement account suffered a loss of $150,000 in interest (the Court record did not state whether the loss of interest was a decline or an increase in the value of the assets in the plan). LaRue argued that his employer should cover the loss, and the Supreme Court said LaRue could sue for this fiduciary breach under ERISA. The Court allowed the lawsuit to continue because fiduciary employer misconduct could reduce the benefits available under the retirement plan in the defined contribution system, whereas administrator misconduct in a defined benefit plan will not affect the retirement benefits unless the misconduct causes a risk of default for the entire plan.

LaRue Might Not Be Able To Recover
LaRue might not be able to recover from his employer even though the Supreme Court allowed him to sue. The case will now go back to the trial court, where LaRue has to prove 1) the fiduciary (employer) had breached its obligations, and 2) the breach had a detrimental effect on LaRue’s plan. The Supreme Court merely said employees could sue their employers for fiduciary breaches related to their 401(k) plans. The Court did not consider whether LaRue correctly followed the procedures and regulations of his plan, whether LaRue must exhaust all other remedies provided for in his plan before suing for the fiduciary breach, or whether LaRue started his lawsuit and asserted his rights early enough to get relief from a court. Lessons From LaRue Employers choose defined contribution plans because of their advantages over defined benefit plans, including less regulation and fewer administrative costs. Additionally, defined contribution plans give employees more control over their retirement, especially in an increasingly mobile job market. Perhaps more important to employers, defined contribution plans shift several risks of defined benefit plans from employers to employees, including the dangers of employees outliving the accumulated assets (longevity risk) in the plan and accumulating insufficient assets (investment risk).

The landscape has now changed again and some risk has been shifted to employers who offer defined contribution plans. Now that employees can sue their employers for mismanaging their 401(k) retirement plan accounts, these retirement plans are riskier than defined benefit plans with respect to lawsuits for fiduciary breaches. For example, employers may be susceptible to lawsuits by disgruntled employees whose retirement plans did not grow as large as the employee had hoped. To better defend themselves against this risk, employers should make sure they understand their fiduciary obligations under ERISA and consider having a qualified investment advisor under contract to perform some or all of those obligations. In addition, documentation will be critical in the event of a lawsuit, so employers should keep notes and records of all activity and discussions regarding changes in their employees’ plans. Though these suggestions will not prevent an ERISA, they will help defend against such a claim if one is made.

Wilke, Fleury, Hoffelt, Gould & Birney, LLP Labor & Employment Newsletter, August 2008, Volume 11, Issue 3