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How Plan Sponsors can avoid 401(k) plan lawsuits

Published by Summit Marketing Team on Jan 3, 2022 2:00:00 PM

Although 401(k)’s are now the most common employer-sponsored retirement plan, it can create a tenuous legal environment for employers and participants alike. Beneficially, 401(k) defined contribution plans easily outperform the once-popular defined benefit pension plan. When the stock market is booming, 401(k) plan participants tend to reap huge benefits even with a more conservative mix of funds. But when the market goes south, 401(k) plans often suffer huge losses, even if those losses are temporary.

Plan participants can get confused and angry in response, making 401(k) plan lawsuits more likely to occur. Plan sponsors can mitigate these risks by employing a few useful strategies.

 

Why Do 401(k) Lawsuits Happen?

There’s some good news when it comes to 401(k) plan lawsuits: They’re exceedingly rare. In the past two decades, one of the worst years for 401(k) plan lawsuits was 2008. Lawsuits increased in direct response to the housing market bubble burst and the subsequent stock market crash. Earlier that year, and before the 2008 market crash began, the U.S. Supreme Court ruled that employees could sue their employers over perceived plan mismanagement. These two events could hardly have been better timed.

The whims of the stock market aren’t the only issues that can create a flurry of 401(k) lawsuits.

In a 2018 study of over 300 401(k) lawsuits from 2006 to 2017, the Center for Retirement Research at Boston College discovered that the most common triggers for lawsuits against 401(k) plan sponsors in one way or another fit into one of three categories:

  1. Inappropriate investment choices
  2. Excessive fees
  3. Self-dealing

Although 401(k) lawsuits are rare, they are trending upward as these employer-sponsored investment vehicles have become the gold standard and most-adopted option. They’re also fairly complex in a way that can make them legal targets beyond the typical market-driven influences. In fact, the number of 401(k) lawsuits increased five-fold in 2020—despite a booming stock market—due primarily to complaints about 401(k) plan fees.

The total number of 401(k) plan lawsuits have rarely surpassed triple digits in any given year, but poor or infrequent communication about plan management, fee structures, withholding, matching or even subtle changes to the plan can create friction and cause plan participants to raise serious questions. Yes, even if those questions are easily answered or are based in misinformation about how the plan works.

Some participants will unfortunately use the nuclear option by either lawyering up and filing a lawsuit or filing a complaint directly with the Department of Labor (or both).

Let this part of the discussion serve as your backdrop into how your company can reduce 401(k) lawsuit risks or strengthen your case if they should occur.

 

Be Transparent About Fees

As mentioned above, 401(k) lawsuits against plan sponsors skyrocketed in 2020 not because of a down stock market, but because of 401(k) fee structures. The concern about fees is not unwarranted. According to a 2014 study by the Center for American Progress (CAP), high 401(k) fees can reduce the long-term growth of a plan by $100,000 or more. That can lead to workers having to delay retirement for several years to compensate.

In an associated article, CAP also explained that some of the problem with fees is that they can be “obscure or misunderstood” as well as “often simply too high”. When plan participants close to retirement start realizing the cumulative impact that fees have had on their investments, they may understandably be angry, especially if they did not realize that those fees existed. Furthermore, if they learn that plan sponsors do have some level of control over fees, this can lead to increased frustration.

Consequently, plan participants may believe their employer could have done more to get those fees reduced. That sticking point is part of several major 401(k) lawsuits, like the one against Costco. As a result of Costco’s high fees and its failure (according to the participants suing) to use its position to seek lower fees, the company is being accused of plan mismanagement and breaching its fiduciary responsibility.

 Your business should do two things to reduce a concern over 401(k) participant fees:

  1.  Be transparent and communicate with participants about your plan’s fees, the cost of those fees, and why the fees are necessary.
  2. When possible, negotiate for lower fees. And if you do, keep your plan participants informed about the efforts you’ve taken to get fees reduced.

As for the latter, reducing fees is not always possible, especially if you have a plan that has a lower managed amount. However, transparency around fees is critical to reducing the information gap that can cause frustration among participants who may perceive a lack of information as intentionally hiding fees and breaching fiduciary responsibilities.

What Plan Sponsors Can do to Avoid 401(k) Plan Lawsuits

 

Communicate Early and Often About How the Plan Works

Over 60% of Americans don’t quite understand how 401(k) plans work. Some of this is because many plan participants simply don’t read the paperwork they receive, especially if you have auto-enrollment. That information gap can create some fairly stressful moments for plan participants when, say, the stock market crashes and they see the value of their investments drop by 25% of more in a matter of weeks.

Any aspect of your plan administration could be ripe for a lawsuit if a dissatisfied employee sues primarily because of a misunderstanding. Communicate everything to your plan participants about how the plan works, as well as their investment options and how much control they have in the process.

 Again, more information is better, but you may want to take an approach that emphasizes active communication about the following:

  • Your cash matching policies
  • If the plan is self-directed, the funds you’ve made available for investment
  • If the plan is trustee-directed, the funds included in each plan, depending on investment scheme (aggressive, conservative, etc.)
  • Whether any of the funds include your company’s own stock (often the source of self-dealing complaints)
  • Regular updates on plan performance

And whether your plans are self-directed or trustee-directed, we recommend that you regularly review plan performance with your investment advisor and investment board. You should have mechanisms in place for identifying plans that appear to be underperforming their peers. How you define “regularly” is up to you, but we recommend doing this quarterly. This can help you more actively find underperforming participant plans or funds and switch our or replace funds that appear to be regularly underperforming the market.

In the above approach, it’s also important to take detailed meeting notes. Should a 401(k) lawsuit or Department of Labor investigation arise, you’ll have evidence on hand that reflects your company’s active approach regarding plan management and administration.

 

Fix Mistakes Early and Transparently

There may be occasions when you make mistakes with how you administer your 401(k) plan. Perhaps someone asks for a certain amount to be withheld, and it doesn’t happen in a timely manner or at all. Or an employee was promised a certain amount in cash matching but received less due to a calculation error. Whatever the issue, if errors arise during the administration of your plan, fix those errors as quickly as possible.

But don’t just fix it and assume that everything is perfect with your employees who were on the receiving end. Communicate to them the problem you identified or mistake you made, and the steps you took to fix that mistake. Complaints and lawsuits are often built upon employees who find out about these mistakes’ months or years later and on their own.

For example, you may have an employee who requests to have her withholding percentage increased from 5% to 10%. If that change takes 6 months to happen, that employee may miss out on large amount of potential future gains, especially given annual 401(k) contribution limits.

Whatever the reason for mistakes, don’t allow employees to independently discover that a mistake occurred. And if a participant does discover an administrative issue before you do, communicate actively about the fix, and keep the participant in the loop for a timeline and steps taken to make that participant feel whole.

 

Takeaways with Mitigating 401(k) Plan Lawsuits

We’ll sum up these ideas with two words: communication and transparency. Every mitigation strategy for reducing the likelihood of an ERISA lawsuit boils down to how effectively you make information about your plan structure and management available to your participants. Overall, participants may become distressed and angry about a plan when they stumble upon an issue independently, or when they feel the plan sponsor has not taken their concerns about a plan seriously.

If there are communication and transparency gaps between yourself and your plan participants, your first and best strategy is to close those gaps to help remove issues of doubt.

 


 

At Summit CPA we know that Plan administration can be a huge burden to companies especially with all the complexities added due to the pandemic. However, don’t let your guard down regarding your 401(k) Plan. It is an important responsibility of the Plan fiduciaries to ensure compliance at all times. A review of current compliance and administration now will help make things a little less stressful. For more information on how we can help, contact our office at (866) 497-9761

 

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