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In this Current outlook we discuss three issues raised in the recent complaint filed against fiduciaries of the Northrop Grumman DC plan that are atypical of 401(k) fee litigation – reimbursement of sponsor direct expenses, use of a flat recordkeeping fee and Financial Engines payments. We then review the recent GAO report 401(K) PLANS: DOL Could Take Steps to Improve Retirement Income Options for Plan Participants. We conclude with a brief note on two recent IRS Notices, extending temporary closed group nondiscrimination relief and publishing mortality tables for 2017.
On September 9, 2016, participants in the Northrop Grumman DC plan filed a lawsuit against Northrop plan fiduciaries. In many respects the allegations in this lawsuit are similar to those in other recently filed 401(k) fee cases. We do, however, want to call attention to three claims that are (somewhat) atypical.
Challenge to direct expense reimbursement. Plaintiffs allege that the plan sponsor overcharged the plan for certain administrative services it provided. DOL regulations allow a plan fiduciary to charge “direct expenses” back to the plan in certain circumstances. The Northrop plaintiffs claim that “Northrop … provided no valuable services, or services of only limited value, to the Plan … [and] failed to engage in a competitive bidding process for the services provided by Northrop employees, or consider outsourcing such services to an independent third party, to ensure that only reasonable and necessary expenses were incurred in the operation and administration of the Plan.” Charging a plan the direct expense of services provided by sponsor employees is not a practice unique to Northrop. It will be interesting to see how this element of the complaint is handled by the court – what standard and level of scrutiny it will apply – and whether plaintiffs’ lawyers will begin targeting other sponsors that charge back administrative costs.
Challenge to flat fee arrangement. According to the complaint, Northrop was (allegedly) paying the plan’s recordkeeper (Hewitt) a flat fee of $500,000 per month, over a period during which the number of plan participants declined by 23%. Plaintiffs allege that, on a per-participant basis, the decline in participants made the flat fee unreasonably high. It will be interesting – especially for sponsors negotiating flat fee recordkeeping arrangements – to see how the court handles this issue. Plaintiffs have had some success (e.g., in Tussey v. ABB) holding plan fiduciaries to a per capita fee standard for recordkeeping where the plan is paying an assets-under-management fee. Will courts buy the same per-participant analysis where a flat fee is involved?
Financial Engines payments. As in the recent lawsuit filed against Fidelity (Fleming v. Fidelity Management Trust Company), the Northrop plaintiffs are challenging an arrangement between the plan, advice provider Financial Engines and the plan’s recordkeeper (Hewitt). Under that arrangement, Financial Engines is alleged to have paid Hewitt “25% of the asset-based advice fee and 35% of the asset-based professional management fees that Plan participants pay to Financial Engines.” Plaintiffs claim that those Financial Engines fees paid to Hewitt (which, as indicated, came out of the fees Financial Engines charged plan participants) were unreasonable because Hewitt did not provide any services for them. Again, it will be interesting to see how the court handles this claim. If plaintiffs are successful, then other plaintiffs’ lawyers may begin targeting plans with similar arrangements.
The Government Accountability Office recently published a report 401(K) PLANS: DOL Could Take Steps to Improve Retirement Income Options for Plan Participants. The report discusses (among other things): the extent to which retirement income options are included in 401(k) plans; the obstacles to their inclusion in plans; challenges participants face in understanding them; and ways to increase their use.
Not surprisingly, GAO found that most DC plans (2/3 of those surveyed) do not include retirement income options of any sort – either annuities or “withdrawal options” (installment payments, systematic withdrawals, or managed payout funds). Mid-size and large employers had the highest adoption rate of withdrawal options. “Industry stakeholders” told GAO that “smaller plans generally have higher adoption rates of in-plan annuity options because they are more likely to use record keepers that are insurers and participate in group annuity contracts.”
GAO found that, while research indicates that participants may be more likely to annuitize part of their benefit (vs. annuitizing the entire benefit), and the Administration has supported partial annuitization, “many plans do not allow partial annuitization,” and it appears that there has been little uptake of this option.
Perhaps the major obstacle to the inclusion of annuities in DC plans remains sponsor concern about fiduciary risk. GAO noted Congressional proposals to address this issue by deferring to state insurance regulators (see our article Senate Finance Committee approves bipartisan retirement savings legislation). It recommended that DOL:
[Clarify] the safe harbor from liability for selecting an annuity provider by providing sufficiently detailed criteria to better enable plan sponsors to comply with the safe harbor requirements related to assessing a provider’s long-term solvency.
But, according to GAO, “A DOL official told us that because the ERISA standard of prudence requires plan fiduciaries to exercise some degree of judgement (sic) in making the annuity provider selection, it precludes development of a simple and easily verifiable checklist.”
The GAO report explored a couple of innovations that are new to the retirement income policy dialog. First, it suggested that DOL consider something like 404(c)-style fiduciary liability relief where a plan offers “an appropriate mix of annuity and withdrawal options.” DOL responded to this recommendation by expressing “concern that it could shift the responsibility for annuity selection from the fiduciary to the participant.” But, GAO stated, DOL is “open to considering alternative regulatory approaches.”
Second, GAO recommended consideration of application of a default DC lifetime distribution option modeled on the required minimum distribution rules. In this regard, GAO cited a White Hose Executive Order Using Behavioral Science Insights to Better Serve the American People, which, among other things, encouraged agencies to:
Identify programs that offer choices and carefully consider how the presentation and structure of those choices, including the order, number, and arrangement of options, can most effectively promote public welfare, as appropriate, giving particular consideration to the selection and setting of default options. [Emphasis added.]
The report noted the problem – also addressed in the recent Senate Finance Committee proposal – presented by the use of in-plan annuities that sometimes must be distributed when, e.g., a plan changes recordkeepers.
And the report found that “[p]articipants we surveyed … cited obtaining advice as a key step in selecting lifetime income options offered by a 401(k) plan.” It’s unclear how much advice participants will be able to get about distribution options generally and retirement income options in particular after the new conflict of interest regulation goes into effect.
The GAO report covers some familiar ground (e.g., concerning the general DC participant bias against annuities) but also includes some interesting ideas.
Finally, we note that on September 19, 2016, IRS (in Notice 2016-57) extended through 2017 temporary relief from Tax Code nondiscrimination rules for closed groups. See our article Frozen plan update for a discussion of this temporary relief and of IRS’s proposal for permanent relief. Our recent article Senate Finance Committee approves bipartisan retirement savings discusses a Congressional alternative to IRS’s proposed permanent relief.
Also in September, IRS (in Notice 2016-50) released mortality tables for use in calculating 2017 minimum funding requirements and lump sum payments. The new tables generally update (by one year) the tables used for 2016 funding (based on RP 2000) and do not reflect new Society of Actuaries tables published in 2014 (which themselves have been the subject of some controversy). IRS indicated that it intends to update its base mortality tables in time for application in 2018.
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We will continue to follow these issues.