Compliance May 4, 2020

Use of Incorrect Compensation Definition Alleged in Lawsuit Against Host International

The plaintiff in the case says Host’s tip policy interferes with his and others’ ability to defer income under the terms of the plan and discriminates against tipped employees.

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A proposed class action lawsuit has been filed against Host International, a provider of meals to various travel and entertainment venues, alleging it and other plan fiduciaries refused to properly defer compensation of certain employees to the HMSHost 401(k) Retirement Savings Plan and Trust pursuant to the terms of the plan document.

The complaint notes that the plan’s adoption agreement provides that participants “may elect to have a portion of their compensation contributed to the plan on a before-tax basis” with a deferral limit of 75% of their compensation. The plan document defines “compensation” as “wages,” as set forth in the Employee Retirement Income Security Act (ERISA) Section 3401(a). That section defines “wages” as “all remuneration … for services performed by an employee for his employer,” while Section 3401(f) provides that, “[f]or purposes of subsection (a), the term ‘wages’ includes tips received by an employee in the course of his employment.”

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The complaint also points out that the plan’s summary plan description (SPD) says “all reported gratuities [are] eligible compensation when determining the eligible contribution amount for the plan.”

The basis for the lawsuit is Host International’s Tips Policy. As explained in the complaint, Host requires tipped employees to report credit card tips recorded by customers on their credit card receipt into the point of sale system. The Tips Policy then requires that the credit card tips be paid in cash to the employee at the end of his or her shift. Host International does not provide its employees with the option to receive those tips later with their compensation paid through payroll. The plaintiff says this interferes with his and proposed class members’ ability to defer income under the terms of the plan.

The plaintiff reached out to benefits staff about the plan’s failure to follow his election to defer 25% of income under the plan. A claims administrator sent him an email that said, “You correctly point out that the plan, at Section 5.03, states that a participant is not permitted to make deferral contributions in excess of his ‘effectively available compensation’ and that ‘effectively available compensation’ is a participant’s compensation remaining after all applicable amounts have been withheld.” Later in the email, she writes that “it is clear that deferrals of compensation under the plan cannot be made from a mere disbursement or payment of unreported tips to you, but rather must be made on ‘effectively available compensation’ in your regular paycheck.”

The claims administrator concludes: “In other words, even though reported tips are included in compensation for purposes of determining the overall amount of deferrals/contributions to the plan, ‘counting’ tips as compensation does not mean the tip amounts are effectively available to withhold deferrals from. As such, to the extent that regular wages are insufficient to withhold elected deferrals from, the plan allows for a participant’s contribution of after-tax amounts.”

According to the complaint, the email goes on and appears to assert that the credit card tips, which Host International requires its tipped employees to report before paying them back out and uses to determine their taxable earnings, are somehow not “employee-reported tips.” The lawsuit says explanations in her letter “are illogical.”

The lawsuit argues that there is “nothing in federal or state withholding laws prohibiting defendants from using a separate mechanism to allow plan participants to defer their reported credit card tips according to their elections. Likewise, there is no provision in the plan that carves out reported credit card tips from being included as ‘effectively available compensation’ qualifying for pre-tax deferrals.”

The plaintiff followed up with a letter to the retirement committee and plan administrator. The response upheld the claims administrator’s conclusion and stated, in part, “[a]s we have previously explained in [the claims administrator’s letter] and in prior correspondence, an employer cannot, under the terms of the plan and federal tax law, make your elected pre-tax deferrals of tip compensation out of anything other than your regular wages paid through payroll that remain after taking deductions for all required tax withholdings and other authorized deductions from your pay.”

The plaintiff then filed the lawsuit alleging that the defendants acted contrary to the plan document by preventing him and others from contributing a portion of their reported tips based on their deferral elections. In addition, the lawsuit alleges that by denying plan participants who are tipped employees the right to defer reported tips, the defendants have violated the anti-discrimination provision of ERISA Section 510. “While highly compensated and/or non-tipped employees are permitted to apply their pre-tax deferral election to the entirety of their reported income, tipped employees such as plaintiff are only permitted to defer a portion of their reported income,” the lawsuit states.

The plaintiff points out that denial of a 401(k) plan participant’s right to defer his or her reported tips not only contradicts the plan document, it potentially jeopardizes the tax-qualified status of the plan.

He further accuses the defendants of failing to prudently consider their interpretation and administration of the plan document and adopting “an arbitrary position … thereby avoiding the need to follow the participant’s election to defer a percentage of the income.”

As a result of the defendants’ alleged fiduciary breaches, the lawsuit says the plan has suffered losses from the contributions from tipped participants, their matching contributions and earnings those contributions would have accrued as plan assets.

Among other things, the lawsuit asks for an accounting of the amounts that would have been contributed to the plan and the earnings those amounts would have generated but for the defendants’ breaches and disgorgement, restitution and/or restoration to the plan of those amounts.

Host International has not yet responded to a request for comment.

Investing May 4, 2020

Market Conditions Highlight Individual Investor Interest Rate Risk

Long a challenge associated with pensions, defined contribution plan investors find themselves grappling with the challenges of interest rate risk amid the coronavirus pandemic.

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It is fairly standard for the typical retirement plan participant to receive education about longevity risk and even sequence of returns risk, but the coronavirus pandemic is underscoring what can be an overlooked and very significant source of risk—interest rates.

“This pandemic and its impacts on the markets and the economy have cast into even greater relief how much risk we have foisted onto participants, on the individual,” observes Josh Cohen, head of institutional defined contribution (DC) for PGIM. “In many ways, the DC plan system has had so many successes, but this is a challenge that we still are solving.”

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Cohen cites statistics published by his colleague Nathan Sheets, PGIM’s chief economist and head of global macroeconomic research, showing just how important DC plan assets have become to middle class Americans as a source of retirement funding. Each household in the top 1% of the wealth distribution has, on average, $25 million of assets, including nearly $10 million of equities. The next 9% of the distribution holds an average of $3.5 million, supported by more than $1 million of average combined defined contribution and defined benefit (DB) plan assets. The next 40% of workers have approximately $60,000 saved on average in the form of public equity ownership, complemented by an average of $128,000 in home equity.

“For the middle class, especially, we know their DC plans are such a big part of their net wealth, in addition to their homes,” Cohen observes.

As such, he says, it is more important than ever to educate individual investors about the many sources of investing risk with which professional money managers and pension funds have long known how to grapple.

“There is the basic market risk, and then there is inflation risk, and of course, longevity risk,” Cohen says. “All of them are significant risks that we need to help people confront and manage. In this current situation, I think we are seeing one underappreciated risk come to the fore, and that is interest rate risk.”

The movement of interest rates can negatively affect retirement plan investors in multiple ways, but the issue Cohen currently sees is tied to the pricing of annuities. Simply put, because “safe assets” such as government bonds or high quality corporate bonds are paying investors very little at this moment in time, it remains very expensive to fund a stream of guaranteed income in retirement. Put another way, if the insurance companies issuing annuities cannot assume that they will generate decent returns from their general accounts’ investment in safe assets such as government bonds, they will not be able to provide an attractive premium to their customers for the sacrifice of liquidity in an annuity purchase—for which they are normally compensated.

“Whether you are talking about guaranteed or non-guaranteed income streams, this is going to remain a very challenging outlook to overcome,” Cohen says. “This is even more of an issue because of the fact that we came into this pandemic with interest rates already quite low.”

Cohen proposes that one way to deal with this challenge is to help individual investors implement the principles of liability-driven investing (LDI), which is an approach to investing long embraced by pensions as a means of addressing various risks, including interest rate risk and sequence of returns risk. LDI basically means making investments with the goal of securing returns that will be sufficient to meet a future funding need—rather than investing to simply maximize returns in an open-ended manner. 

In a conversation last year with PLANSPONSOR, Aaron Meder, CEO of Legal & General Investment Management America (LGIMA), said investment managers in the United States are slowly but surely bringing LDI principles to DC plan investors. Meder said the analog of defined benefit liability-driven investing on the DC plan side is the discussion of “in-plan guaranteed retirement income.”

“So, on the pension LDI side, the objective is to have the liquid assets in hand when you need them to pay your pension liabilities,” Meder said. “It’s really kind of the same idea on the DC side—a successful outcome is about having sufficient money available when you need it and for as long as you need it. Pension plans are managing this goal for a whole population of people, while DC plans are serving individual account holders.”

One important caveat, Meder pointed out, is that LDI strategies must be informed by a plan sponsor’s goals for the DC plan. In other words, an LDI approach will look different based on whether the DC plan is designed to be the main source of retirees’ income or if it is supplemental.

“Full income replacement is not the goal of every DC plan,” Meder said. “Many are designed to be more supplementary in nature. The defining of goals is an important discussion to have when thinking about LDI, both for DB and DC plans.”

Practically speaking, in the near term, Meder said using LDI in DC plans could mean doing a re-evaluation of the fixed-income investments offered. Just like DB plans have reconsidered holding a basic core fixed-income portfolio, which does not match their liability duration, and instead have embraced longer-duration fixed income, DC plan investors may consider doing the same, Meder said.

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