An allowance is often a child’s first brush with financial independence. With allowance money in hand, your child can begin saving and budgeting for the things he or she wants.

It’s up to you to decide how much to give your child based on your values and family budget, but a rule of thumb used by many parents is to give a child 50 cents or 1 dollar for every year of age. To come up with the right amount, you might also want to consider what your child will need to pay for out of his or her allowance, and how much of it will go into savings.

Some parents ask their child to earn an allowance by doing chores around the house, while others give their child an allowance with no strings attached. If you’re not sure which approach is better, you might want to compromise. Pay your child a small allowance, and then give him or her the chance to earn extra money by doing chores that fall outside of his or her normal household responsibilities.

If you decide to give your child an allowance, here are some things to keep in mind:

• Set some parameters. Sit down and talk to your child about the types of purchases you expect him or her to make, and how much of the allowance should go towards savings.
• Stick to a regular schedule. Give your child the same amount of money on the same day each week.
• Consider giving an allowance “raise” to reward your child for handling his or her allowance well.

Lesson 2: Opening a Bank Account

Taking your child to your local bank or credit union to open an account (or opening an account online) is a simple way to introduce the concept of saving money. Your child will learn how savings accounts work, and will soon enjoy making deposits.

Many banks and credit unions have programs that provide activities and incentives designed to help children learn financial basics. Here are some other ways you can help your child develop good savings habits:

• Help your child understand how interest compounds by showing him or her how much “free money” has been earned on deposits.
• Offer to match whatever your child saves towards a long-term goal.
• Let your child take a few dollars out of the account occasionally. Young children who see money going into the account but never coming out may quickly lose interest in saving.

Lesson 3: Setting and Saving for Financial Goals

When your children get money from relatives, you want them to save it for college, but they’d rather spend it now. Let’s face it: children don’t always see the value of putting money away for the future. So how can you get your child excited about setting and saving for financial goals? Here are a few ideas:

• Let your child set his or her own goals (within reason). This will give your child some incentive to save.
• Encourage your child to divide his or her money up. For instance, your child might want to save some of it towards a long-term goal, share some of it with a charity, and spend some of it right away.
• Write down each goal, and the amount that must be saved each day, week, or month to reach it. This will help your child learn the difference between short-term and long-term goals.
• Tape a picture of an item your child wants to a goal chart, bank, or jar. This helps a young child make the connection between setting a goal and saving for it.

Finally, don’t expect a young child to set long-term goals. Young children may lose interest in goals that take longer than a week or two to reach. And if your child fails to reach a goal, chalk it up to experience. Over time, your child will learn to become a more disciplined saver.

Lesson 4: Becoming a Smart Consumer

Commercials. Peer pressure. The mall. Children are constantly tempted to spend money but aren’t born with the ability to spend it wisely. Your child needs guidance from you to make good buying decisions. Here are a few things you can do to help your child become a smart consumer:

• Set aside one day a month to take your child shopping. This will encourage your child to save up for something he or she really wants rather than buying something on impulse.
• Just say no. You can teach your child to think carefully about purchases by explaining that you will not buy him or her something every time you go shopping. Instead, suggest that your child try items out in the store, then put them on a birthday or holiday wish list.
• Show your child how to compare items based on price and quality. For instance, when you go grocery shopping, teach him or her to find the prices on the items or on the shelves, and explain why you’re choosing to buy one brand rather than another.
• Let your child make mistakes. If the toy your child insists on buying breaks, or turns out to be less fun than it looked on the commercials, eventually your child will learn to make good choices even when you’re not there to give advice.

Source: Broadridge Investor Communication Solutions, Inc.

When you die, you leave behind your estate. Your estate consists of your assets—all of your money, real estate, and worldly belongings. Your estate also includes your debts, expenses, and unpaid taxes. After you die, somebody must take charge of your estate and settle your affairs. This person will take your estate through probate, a court-supervised process that winds up your financial affairs after your death. The proceedings take place in the state where you were living at the time of your death. Owning property in more than one state can result in multiple probate proceedings. This is known as ancillary probate.

How Does Probate Start?

If your estate is subject to probate, someone (usually a family member) begins the process by filing an application for the probate of your will. The application is known as a petition. The petitioner brings it to the probate court along with your will. Usually, the petitioner will file an application for the appointment of an executor at the same time. The court first rules on the validity of the will. Assuming that the will meets all of your state’s legal requirements, the court will then rule on the application for an executor. If the executor meets your state’s requirements and is otherwise fit to serve, the court generally approves the application.

What’s an Executor?

The executor is the person whom you choose to handle the settlement of your estate. Typically, the executor is a spouse or a close family member, but you may want to name a professional executor, such as a bank or attorney. You’ll want to choose someone whom you trust will be able to carry out your wishes as stated in the will. The executor has a fiduciary duty—that is, a heightened responsibility to be honest, impartial, and financially responsible. Now, this doesn’t mean that your executor has to be an attorney or tax wizard, but merely has the common sense to know when to ask for specialized advice.

Your executor’s duties may include:

• Finding and collecting your assets, including outstanding debts owed to you
• Inventorying and appraising your assets
• Giving notice to your creditors (e.g., credit card companies, banks, retail stores)
• Filing an estate tax return and paying estate taxes, if any
• Paying any debts or other taxes
• Distributing your assets according to your will and the law
• Providing a detailed report of how the estate was settled to the court and all interested parties

The probate court supervises and oversees the entire process. Some states allow a less formal process if the estate is small and there are no complicated issues to resolve. In those states allowing informal probate, the court may be involved only indirectly. This may speed up the probate process, which can take years.

What If You Don’t Name an Executor?

If you don’t name an executor in your will, or if the executor can’t serve for some reason, the court will appoint an administrator to settle your estate according to the terms of your will. If you die without a will, the court will also appoint an administrator to settle your estate. This administrator will follow a special set of laws, known as intestacy laws, that are made for such situations.

Is All of Your Property Subject to Probate?

Although most assets in your estate may pass through the probate process, other assets may not. It often depends on the type of asset or how an asset is titled. For example, many married couples own their residence jointly with rights of survivorship. Property owned in this manner bypasses probate entirely and passes by operation of law. That is, at death, the property passes directly to the joint owner regardless of the terms of the will and without going through probate. Other assets that may bypass probate include:

• Investments and bank accounts set up to pass automatically to a named person at death (payable on death)
• Life insurance policies with a named beneficiary (someone other than the estate)
• Retirement plans with a named beneficiary
• Other property owned jointly with rights of survivorship

Source: Broadridge Investor Communication Solutions, Inc.

The best time to plan for the possibility of nursing home care is when you’re still healthy. By doing so, you may be able to pay for your long-term care and preserve assets for your loved ones. How? Through Medicaid planning.

Eligibility for Medicaid Depends on Your State’s Asset and Income-Level Requirements

Medicaid is a joint federal-state program that provides medical assistance to various low-income individuals, including those who are aged (i.e., 65 or older), disabled, or blind. It is the single largest payer of nursing home bills in America and is the last resort for people who have no other way to finance their long-term care. Although Medicaid eligibility rules vary from state to state, federal minimum standards and guidelines must be observed.

In addition to you meeting your state’s medical and functional criteria for nursing home care, your assets and monthly income must each fall below certain levels if you are to qualify for Medicaid. However, several assets (which may include your family home) and a certain amount of income may be exempt or not counted.

Medicaid Planning Can Help You Meet Your State’s Requirements

To determine whether you qualify for Medicaid, your state may count only the income and assets that are legally available to you for paying bills. That’s where Medicaid planning comes in. Over the years, a number of tools and strategies have arisen that might help you qualify for Medicaid sooner.

In general, Medicaid planning seeks to accomplish the following goals:

• Exchanging countable assets for exempt assets to help you meet Medicaid eligibility requirements
• Preserving assets for your loved ones
• Providing for your healthy spouse (if you’re married)

Let’s look at these in turn.

You May Be Able to Exchange Countable Assets for Exempt Assets

Countable assets are those that are not exempt by state law or otherwise made inaccessible to the state for Medicaid purposes. The total value of your countable assets (together with your countable income) will determine your eligibility for Medicaid. Under federal guidelines, each state compiles a list of exempt assets. Usually, this list includes such items as the family home (regardless of value), prepaid burial plots and contracts, one automobile, and term life insurance.

Through Medicaid planning, you may be able to rearrange your finances so that countable assets are exchanged for exempt assets or otherwise made inaccessible to the state. For example, you may be able to pay off the mortgage on your family home, make home improvements and repairs, pay off your debts, purchase a car for your healthy spouse, and prepay burial expenses.

For more information on this topic, contact an elder law attorney who is experienced with your state’s Medicaid laws.

Irrevocable Trusts Can Help You Leave Something for Your Loved Ones

Why not simply liquidate all of your assets to pay for your nursing home care? After all, Medicaid will eventually kick in (in most states) once you’ve exhausted your personal resources. The reason is simple: You want to assist your loved ones financially.

There are many ways to potentially preserve assets for your loved ones. One way is to use an irrevocable trust. (It’s irrevocable in the sense that you can’t later change its terms or decide to end it.) Property placed in an irrevocable trust will be excluded from your financial picture, for Medicaid purposes. If you name a proper beneficiary, the principal that you deposit into the trust (and possibly any income generated) will be sheltered from the state and can be preserved for your heirs. Typically, though, the trust must be in place and funded for a specific period of time for this strategy to be an effective Medicaid planning tool.

For information about Medicaid planning trusts, consult an experienced attorney.

If You’re Married, an Annuity Can Help You Provide for Your Healthy Spouse

Nursing homes are expensive. If you must go to one, will your spouse have enough money to live on? With a little planning, the answer is yes. Here’s how Medicaid affects a married couple. A couple’s assets are pooled together when the state is considering the eligibility of one spouse for Medicaid. The healthy spouse is entitled to keep a spousal resource allowance that generally amounts to one-half of the assets. This may not amount to much money over the long term.

A healthy spouse may want to use jointly owned, countable assets to buy a single premium immediate annuity to benefit himself or herself. Converting countable assets into an income stream is a plus because each spouse is entitled to keep all of his or her own income, in contrast to the pooling of assets. By purchasing an immediate annuity in this manner, the institutionalized spouse can more easily qualify for Medicaid, and the healthy spouse can enjoy a higher standard of living.

Be aware, however, that for annuities purchased on February 8, 2006, and thereafter (the date of enactment of the Deficit Reduction Act of 2005), the state must be named as the remainder beneficiary of the annuity after your spouse or a minor or disabled child.

Beware of Certain Medicaid Planning Risks

Medicaid planning is not without certain risks and drawbacks. In particular, you should be aware of look-back periods, possible disqualification for Medicaid, and estate recoveries.

When you apply for Medicaid, the state has the right to review, or look back, at your finances (and those of your spouse) for a period of months before the date you applied for assistance. In general, a 60-month look-back period exists for transfers of countable assets for less than fair market value. Transfers of countable assets for less than fair market value made during the look-back period will usually result in a waiting period before you can start to collect Medicaid. So, for example, if you give your house to your kids the year before you enter a nursing home, you’ll be ineligible for Medicaid for quite some time. (A mathematical formula is used.)

Also, you should know that Medicaid planning is more effective in some states than in others. In addition, federal law encourages states to seek reimbursement from Medicaid recipients for Medicaid payments made on their behalf. This means that your state may be able to place a lien on your property while you are alive, or seek reimbursement from your estate after you die. Make sure to consult an attorney experienced with Medicaid planning and the laws in your state before taking any action.

Source: Broadridge Investor Communication Solutions, Inc.

529 plans can be powerful college savings tools, but you need to understand how your plan works before you can take full advantage of it. Among other things, this means becoming familiar with the finer points of contributions and withdrawals.

How Much Can You Contribute?

To qualify as a 529 plan under federal rules, a state program must not accept contributions in excess of the anticipated cost of a beneficiary’s qualified education expenses. At one time, this meant five years of tuition, fees, and room and board at the costliest college under the plan, pursuant to the federal government’s “safe harbor” guideline. Now, however, states are interpreting this guideline more broadly, revising their limits to reflect the cost of attending the most expensive schools in the country and including the cost of graduate school. As a result, most states have contribution limits of $350,000 and up (and most states will raise their limits each year to keep up with rising college costs).

A state’s limit will apply to either kind of 529 plan: savings plan or prepaid tuition plan. For a prepaid tuition plan, the state’s limit is a limit on the total contributions. For example, if the state’s limit is $300,000, you can’t contribute more than $300,000. On the other hand, a savings plan limits the value of the account for a beneficiary. When the value of the account (including contributions and investment earnings) reaches the state’s limit, no more contributions will be accepted. For example, if the state’s limit is $400,000 and you contribute $325,000 and the account has $75,000 of earnings, you won’t be able to contribute any more—the total value of the account has reached the $400,000 limit.

These limits are per beneficiary, so if two people each open an account for the same beneficiary with the same plan, the combined contributions can’t exceed the plan limit. If you have accounts in more than one state, ask each plan’s administrator if contributions to other plans count against the state’s maximum. Generally, contribution limits don’t cross state lines. In other words, contributions made to one state’s 529 plan don’t count toward the lifetime contribution limit in another state. But check the rules of each state’s plan.

How Little Can You Start Off With?

Some plans have minimum contribution requirements. This could mean one or more of the following: (1) you have to make a minimum opening deposit when you open your account, (2) each of your contributions has to be at least a certain amount, or (3) you have to contribute at least a certain amount every year. But some plans may waive or lower their minimums (e.g., the opening deposit) if you set up your account for automatic payroll deductions or bank-account debits. Some will also waive fees if you set up such an arrangement. (A growing number of companies are letting their employees contribute to savings plans via payroll deduction.) Like contribution limits, minimums vary by plan, so be sure to ask your plan administrator.

Know Your Other Contribution Rules

Here are a few other basic rules that apply to most 529 plans:

• Only cash contributions are accepted (e.g., checks, money orders, credit card payments). You can’t contribute stocks, bonds, mutual funds, and the like. If you have money tied up in such assets and would like to invest that money in a 529 plan, you must liquidate the assets first.
• Contributions may be made by virtually anyone (e.g., your parents, siblings, friends). Just because you’re the account owner doesn’t mean you’re the only one who’s allowed to contribute to the account.
• 529 savings plans typically offer several different investment portfolios that you can pick from to invest your contributions. If you want to change your investment option, you can generally do so twice per calendar year for your existing contributions, anytime for your future contributions, or anytime you change the beneficiary of the account.
• 529 account owners who are interested in making K-12 contributions or withdrawals should understand their state’s rules regarding how K-12 funds will be treated for tax purposes. Some states may not follow the federal tax treatment. In addition, account owners should check with the 529 plan administrator to determine whether a K-12 withdrawal request should be made payable to the account owner, the beneficiary, or the K-12 institution.

Maximizing Your Contributions

Although 529 plans are tax-advantaged vehicles, there’s really no way to time your contributions to minimize federal taxes. (If your state offers a generous income tax deduction for contributing to its plan, however, consider contributing as much as possible in your high-income years.) But there may be simple strategies you can use to get the most out of your contributions.

For example, investing up to your plan’s annual limit every year may help maximize total contributions. Also, a contribution of $16,000 a year or less in 2022 qualifies for the annual federal gift tax exclusion. And under special rules unique to 529 plans, you can gift a lump sum of up to five times the annual gift tax exclusion—$80,000 for individual gifts or $160,000 for joint gifts—and avoid federal gift tax, provided you make an election on your tax return to spread the gift evenly over five years. This is a valuable strategy if you wish to remove assets from your taxable estate.

Lump-Sum vs. Periodic Contributions

A common question is whether to fund a 529 plan gradually over time, or with a lump sum. The lump sum would seem to be better because 529 plan earnings grow tax deferred—so the sooner you put money in, the sooner you can start to potentially generate earnings. Investing a lump sum may also save you fees over the long run. But the lump sum may have unwanted gift tax consequences, and your opportunities to change your investment portfolio are limited. Gradual investing may let you easily direct future contributions to other portfolios in the plan. And realistically, many parents may not be able to fund their account with a lump sum, but they may be able to easily make monthly investments.

Qualified Withdrawals Are Tax Free

Withdrawals from a 529 plan that are used to pay qualified education expenses are completely free from federal income tax and may also be exempt from state income tax. For 529 savings plans, qualified education expenses include the full cost of tuition, fees, books, equipment, and room and board (assuming the student is attending at least half-time) at any college or graduate school in the United States or abroad that is accredited by the Department of Education; the cost of certified apprenticeship programs (fees, books, supplies, equipment); student loan repayment (there is a $10,000 lifetime limit per 529 plan beneficiary and $10,000 per each of the beneficiary’s siblings); and K-12 tuition expenses up to $10,000 per year.

Note: A 529 plan must have a way to make sure that a withdrawal is really used for qualified education expenses. Many plans require that the college be paid directly for education expenses; others will prepay or reimburse the beneficiary for such expenses (receipts or other proof may be required).

Beware of Nonqualified Withdrawals

A nonqualified withdrawal is any withdrawal that’s not used for qualified education expenses. For example, if you take money from your account for medical bills or other necessary expenses, you’re making a nonqualified withdrawal. The earnings portion of any nonqualified withdrawal is subject to federal income tax and a 10 percent federal penalty (and may also be subject to a state penalty and income tax).

Is Timing Withdrawals Important?

As account owner, you can decide when to withdraw funds from your 529 plan and how much to take out—and there are ways to time your withdrawals for maximum advantage. It’s important to coordinate your withdrawals with the education tax credits (American Opportunity credit and Lifetime Learning credit). That’s because the tuition expenses that are used to qualify for a credit can’t be the same tuition expenses paid with tax-free 529 funds. A tax professional can help you sort this out to ensure that you get the best overall results. It’s also a good idea to wait as long as possible to withdraw from the plan. The longer the money stays in the plan, the more time it has to grow tax deferred.

Note: Before investing in a 529 plan, please consider the investment objectives, risks, charges, and expenses carefully. The official disclosure statements and applicable prospectuses, which contain this and other information about the investment options, underlying investments, and investment company, can be obtained by contacting your financial professional. You should read these materials carefully before investing. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated. Investment earnings accumulate on a tax-deferred basis, and withdrawals are tax-free as long as they are used for qualified education expenses. For withdrawals not used for qualified education expenses, earnings may be subject to taxation as ordinary income and possibly a 10% federal income tax penalty. The tax implications of a 529 plan should be discussed with your legal and/or tax professionals because they can vary significantly from state to state. Also be aware that most states offer their own 529 plans, which may provide advantages and benefits exclusively for their residents and taxpayers. These other state benefits may include financial aid, scholarship funds, and protection from creditors.

Source: Broadridge Investor Communication Solutions, Inc.

U.S. stocks sold off sharply yesterday in one of the worst trading days of 2022. The S&P 500 Index of large-cap U.S. stocks fell more than 3.5 percent and the technology-oriented NASDAQ Index fell almost 5 percent. These moves erased the indexes’ big gains from Wednesday as markets rallied after Federal Reserve Chairman Jerome Powell ruled out larger interest rate hikes. This week’s major market moves highlight an already-challenging year for stock investors. The bond market is experiencing a similarly challenging time.

Coming into 2022, U.S. large-cap stocks, as measured by the S&P 500, had doubled over the prior three years. This remarkable run included two years where investors captured returns greater than 25 percent and experienced little anxiety, with only a few short-lived periods of market volatility.

It’s important to remember that periods like 2019 through 2021 are anomalies and that pullbacks of 5 to 10 percent typically happen about every year. Pullbacks of 10 percent or more have happened every three to five years. In other words, periods of volatility like the one we are currently experiencing are more the rule than the exception.

Investors are grappling with several macroeconomic concerns, including inflation at levels not seen in decades, the uncertain impact of the war in Ukraine, and the risk of a Fed policy mistake that over- or under-shoots the hoped-for soft economic landing without sending the economy into recession. No doubt, the Fed faces a very difficult task, and it is too early to know if it will be able to orchestrate the desired outcome.

These macroeconomic forces—and their resulting headlines—are the current drivers of recent stock market moves, pushing more than half of the companies in the S&P 500 into bear-market territory—down more than 20 percent from their highs. Interestingly, industry analysts remain optimistic, forecasting continued growth in corporate revenues and earnings for 2022 and 2023. Clearly, this message has been obscured by recent news.

While stock markets have been grabbing the headlines, bond markets have also been hit. After 40 years of smooth sailing, investors were reminded in early 2022 that bonds are not risk free. They have provided little or no diversification benefit during this period of stock market volatility. However, there are two significant differences between stock market volatility and bond market volatility.

First, absent a default, a bond’s expected return is always known, captured by its yield to maturity. While bonds can generate price losses, assuming no credit impairment, the bondholder will eventually receive the interest payments and principal, earning the yield to maturity stated at the time the bond was purchased.

As importantly, short-term pain can often lead to longer-term gains in bond markets. History tells us that bond market pain generally translates to a more favorable future. For example, an investor who bought a 2-year Treasury on January 1 could expect an annual return of 0.78 percent over the life of the bond. Today, an investor purchasing that same security can expect a 2.71 percent annual return.

As always, a well-diversified portfolio tailored to your appetite for risk and unique financial goals and objectives is the best long-term strategy and can help provide the peace of mind necessary to stay the course through volatile markets. You should expect continued market volatility as investors weigh new data and adjust their expectations. This recalibration can take time as trends and a better understanding of the risks and impacts emerge.

Periods like the one we are experiencing are causes of concern, but they also create opportunity for long-term investors. Market pullbacks provide investors with catalysts to consider their asset allocations and ensure that they are taking an appropriate level of risk. They also provide opportunities to rebalance—by buying the weaker asset class with proceeds harvested from the stronger—to keep portfolio risk levels in check.

We will be following developments closely and will keep you up to date. If you have questions or concerns, please do not hesitate to bring them to our attention.

DOL Weighs In on Cryptocurrencies in 401(k) Plans: Be Very Careful … and Audits Are Coming

The U.S. Department of Labor (DOL) issued a Compliance Assistance Release in March cautioning 401(k) plan fiduciaries “to exercise extreme care” before they consider adding a cryptocurrency option to a plan’s investment menu. The release included the DOL’s view that, “When plan fiduciaries, charged with the duties of prudence and loyalty, choose to include a cryptocurrency option on a 401(k) plan’s menu, they effectively tell the plan’s participants that knowledgeable investment experts have approved the cryptocurrency option as a prudent option for plan participants.” Although focused on cryptocurrency, the release also references a wide range of digital assets. Importantly, the release is not a formal regulation with the force of law, but it does make clear the DOL’s negative view of cryptocurrencies and other digital assets. 

Although the release was directed primarily to 401(k) plan fiduciaries, it referenced defined contribution plans more broadly and can be anticipated to apply to all plans offering participant-directed investments, including 403(b) plans. The DOL also addressed the possible availability of cryptocurrencies in self-directed brokerage windows, which is addressed below.

Specific issues the DOL called out, which fiduciaries should consider if evaluating cryptocurrencies, include:

• They are “highly speculative” and have been “subject to extreme price volatility.” Extreme volatility can have a “devastating impact” on plan participants.
• It is harder for participants to make informed investment decisions about cryptocurrencies than other investments. It can be “extraordinarily” difficult for even expert investors to separate the facts from the hype about cryptocurrencies.
• Cryptocurrencies are not held in the same way as other investments, presenting a variety of potential issues.
• There is not a commonly accepted approach to how cryptocurrencies are valued. Also, cryptocurrency market intermediaries are not subject to the same reporting and data integrity requirements as more traditional investments.
• The regulatory environment for cryptocurrencies is evolving, and some market participants may be operating outside the regulatory framework. Additionally, cryptocurrencies have reportedly been used in a variety of illegal activities, which could result in limitations on the use of specific offerings.

In an unusual step, following this cautionary list of issues, the DOL also notes that it expects to conduct an investigative program “aimed” at plans that offer participant investments in cryptocurrencies and related products. Any plan fiduciaries considering the addition of cryptocurrencies may want to consider involving legal counsel.

Self-Directed Brokerage Accounts: DOL Cryptocurrency Release Opens Door to Examining What Is Offered Through the Account

At the end of its Compliance Assistance Release on digital currencies, discussed above, the DOL added a further caution to plan fiduciaries whose plans offer self-directed brokerage accounts. A self-directed brokerage account option permits a participant to use a brokerage account as one of their 401(k) plan investment options. Using the brokerage account, they can invest 401(k) plan assets in anything available in the brokerage account. 

In the release, the DOL said that fiduciaries whose plans permit self-directed brokerage accounts should expect to be questioned on how they have “squared” their responsibility for plan oversight with the DOL’s serious concerns about cryptocurrency. This seems to open a new area of evaluation by the DOL into what is available through self-directed brokerage accounts.

There is a fiduciary responsibility to select the self-directed brokerage offering and monitor that it is functioning properly and without issues. However, until now it has been generally understood that there is not a fiduciary responsibility to monitor the specific investments offered through the brokerage account. The release seems to lay that responsibility at plan fiduciaries’ feet with respect to cryptocurrencies. It also raises the possibility that other investments available through a self-directed brokerage program may be challenged.

Fiduciaries whose plans offer a self-directed brokerage option should evaluate whether their brokerage account includes cryptocurrencies or other digital assets the DOL is challenging.

Pension Actuarial Equivalence Lawsuits Update

At least 14 lawsuits have been filed alleging that pension plans paid improperly low benefits to some pensioners and their survivors by using incorrect actuarial assumptions. Generally, these cases allege that outdated mortality assumptions or interest rates were used to calculate joint and survivor or early retirement benefits, resulting in understated benefits, violating ERISA’s rules. 

It has been reported that half of these cases have been resolved. Only two monetary settlements have been reported: one for approximately $59 million, where the claim was for approximately $150 million, and the other for $2.8 million. Motions to dismiss in two of the remaining cases were recently issued and came to opposite conclusions.

In Belknap v. Partners Healthcare System, Inc. (D. Mass. 2022), an early retirement (age 62) joint and survivor benefit was calculated using a mortality table from 1951 and an interest rate of 7.5 percent—as prescribed by the plan. In the same plan, for standard single life annuities, up-to-date assumptions including the 2000 mortality table and market-based interest rates (likely 3.7 percent) are used. The suit alleges that, if the early retirement was calculated using the current mortality table and an appropriate interest rate, the monthly difference to the participant would be $33.48, with a present value of $5,840. The judge evaluated the law and did not find a requirement that reasonable actuarial assumptions be used. Rather, he found that the plan’s dictated assumptions should be used and dismissed the case. An appeal has been filed.

In Urlab v. CITGO Petroleum Corp. (ND Ill. 2022), an early retirement (age 62) joint and survivor benefit was calculated using 1971 mortality tables and an interest rate of 8 percent. The plan sponsor argued that the applicable law does not require the use of reasonable actuarial assumptions. The judge rejected this argument, saying, “[I]t cannot possibly be the case that ERISA’s actuarial equivalence requirements allow the use of unreasonable mortality assumptions.” For this and other reasons, the motion to dismiss was denied and the case will proceed.

There have been no full trials of these cases, and a pattern of outcomes cannot be discerned from the settlements and motion to dismiss rulings at this time. However, outcome of the appeal in Belknap may be informative.

Fee Litigation Update

The flow continues of new cases, decisions, and settlements alleging fiduciary breaches through the overpayment of fees and the retention of underperforming investments in 401(k) and 403(b) plans. A sound process for periodically assessing the reasonableness of fees and expenses and monitoring documents is essential to the defense of these cases. Following is a sampling of this quarter’s developments, including appellate court reversal of two cases that had been dismissed in favor of plan fiduciaries and a new suit against fiduciaries of a plan with only $70 million in assets. Fiduciaries of smaller plans cannot assume that they will not be targeted. 

Following is a summary of recent developments:

• New Case Filed Against Smaller Plan—Most plans that have been sued alleging overpayment of recordkeeping fees and investment expenses have had approximately $1 billion in assets or more. A plan with only $70 million has recently been sued in a case making nearly identical allegations to those in the larger plan cases and requesting class action status. Aquino v. 99 Cents Only Stores, LLC (C.D. Cal. 2022)
• Dismissed Cases Reinstated—We previously reported on Davis v. Salesforce.com, Inc. and Kong v. Trader Joe’s Co., both of which were dismissed because the complaints did not include sufficient allegations. Each dismissal was reversed by a separate panel of the U.S. Court of Appeals for the Ninth Circuit. In both instances, the court of appeals found the allegations in the complaints to be sufficient for the case to proceed. Davis v. Salesforce.com, Inc. (9^th Cir. 2022), Kong v. Trader Joe’s Co. (9^th Cir. 2022). 

New Cases with Mixed Dismissal Results:

• Case was initially dismissed and survives dismissal after an amended complaint was filed. Johnson v. PNC Financial Services Group (D. N.C. 2022).
• After plaintiffs were given the opportunity to file an amended complaint, the new complaint was found to be insufficient and dismissed with prejudice. This means that the case is finished and cannot be refiled. Matney v. Barrick Gold of North America, Inc. (D. Utah 2022)
• New case dismissed with leave to file an amended complaint in 28 days. Perkins v. United Surgical Partners International, Inc. (N.D. Tex. 2022)
• New case survives motion to dismiss. Cunningham v. USI Insurance Services, LLC (S.D. N.Y. 2022)

Fiduciary Breach in Evasive and Incomplete Participant Communications

Sean Smarra was a participant in the Boilermaker-Blacksmith National Pension Trust, the defined benefit pension plan for Boilermakers union members. He worked as a boilermaker until he was permanently disabled at age 42. Under the Boilermakers pension plan, a fully disabled plan participant is eligible to begin receiving lifetime pension benefits. The plan was amended in January 2017 to substantially reduce the amount of disability benefits based on the participant’s age when requesting benefits if they are not yet age 55. To qualify for an unreduced disability pension benefit, plan participants were required to apply for benefits by August 14, 2017. 

When he was age 45, in March 2017, Smarra contacted Stacy Higgins at the pension plan’s administration firm to ask about his disability retirement benefit. Although he did not say he wanted to begin receiving retirement benefits immediately, Higgins understood his intention to retire soon. Indeed, she mailed him a pension retirement packet the next day. However, she did not inform Smarra that the plan had been amended and that he would receive a reduced benefit if he did not submit his retirement papers by August 14. Because Smarra was only 45, his benefit reduction would be approximately 60 percent.

Higgins was aware of the plan change and the deadline to receive unreduced benefits. However, she and other employees at the pension administrator were affirmatively instructed to not raise or discuss upcoming changes with participants who contacted them. They were also instructed to not respond to participant questions on the subject.

When Smarra applied for benefits later in 2017, he was informed that his benefit would be $1,393 per month, rather than the $3,804 he was quoted about a year earlier. Disappointed that his lifetime monthly benefit had been reduced by more than 60 percent, he sued.

The judge observed that fiduciary responsibilities under ERISA “encompass not only a negative duty not to misinform, but also an affirmative duty to inform when the [fiduciary] knows that that silence might be harmful.” The Boilermakers argued that Higgins, as a staff person, was not acting in a fiduciary capacity. The judge disagreed, noting that Boilermakers as the plan fiduciary is responsible for Higgins’s failure to provide Smarra the information he needed to protect his benefits.

Finding that a trial would be unnecessary, the judge entered summary judgment in favor of Smarra. Smarra v. Boilermaker-Blacksmith National Pension Trust (W.D. Penn. 2022). The case is now on appeal. 

What sits on a company’s balance sheet for a very long time, is highly complex, and costs a bunch to maintain? The answer: a pension plan. In fact, there are currently more than $3 trillion in U.S. plan assets held by private-sector pension plans.

Sound like a heavy responsibility? It is. And it is precisely why sponsors of defined benefit (DB) plans have been reviewing their plans’ statuses and costs with an eye toward managing risk, says Arthur Scalise, New York City-based director of actuarial services at CAPTRUST.

A form of pension risk management known as pension risk transfer (PRT) is the process of transferring a defined benefit plan’s risk away from an employer who sponsors a pension plan. It represents “a shift from an asset-only risk focus to managing pension plan assets and liabilities, while minimizing volatility generated by the plan’s surplus risk,” Scalise says.

Risk transfer or de-risking transactions addressing pension plan risks can include, for example, the purchase of annuities from an insurance company that transfers liabilities for some or all plan participants; the payment of lump sums to pension plan participants that satisfy the liability of the plan for those participants (either through a one-time offer or a permanent plan feature); and the restructuring of plan investments to reduce risk to the plan sponsor.

Moreover, with an estimated total volume between $38 billion and $40 billion in U.S. pension transactions, the 2021 PRT market exceeded 2020’s record of $27 billion and its highest value to date—$36 billion in 2012.

So … Why Are So Many Plan Sponsors Checking Out PRT?

The current interest rate environment is a tailwind for pension risk transfer, says Scalise. “It is at the top of the leader board when it comes to reasons for plan sponsors to initiate a PRT.” Favorable interest rates have helped many pensions get close to full funding. “That is a core gauge of a plan’s health—a measure of plan assets relative to liabilities—and it hasn’t looked this good since before the 2008 financial crisis,” he says.

Another biggie making PRTs more attractive? Pension plan participants living longer. According to a recent analysis by Club Vita, mortality rates have been improving much more quickly for U.S. pension plan participants than for other Americans (around 0.8 percent per year higher among those who are over 65 years old). This increase in longevity, particularly for a very large population of pension plan participants, can increase plan costs. According to Scalise, if this pace documented in this analysis continues, the existing life expectancy gap between pension plan participants and the U.S. population will widen by one year by the late 2020s.

And don’t forget the historically favorable annuity buyout market—another influence nudging plan sponsors to offload retiree liabilities. Data from the Milliman Pension Buyout Index tells us retiree buyout costs dropped to record lows by the end of 2020 (competitive rates dropped from 103.3 percent at the beginning of 2020 to 99.3 percent at the beginning of 2021), and stayed low through all of 2021 (with competitive rates between 99.3 percent and 100.2 percent).

Might we also suggest that smaller plan sponsors are finding validation in the actions of larger corporations? For example, there is no shortage of plan sponsors who say pension risk management transactions completed by major Fortune 500 corporations increase the likelihood that they would consider offloading pensions to insurers themselves, says Scalise. “Large and mid-sized corporations tend to follow in the footsteps of Fortune 500 companies because those are typically the first movers.”

How Should Plan Sponsors Be Thinking About PRT?

”For plan sponsors who are curious, or who feel that PRT may be in the pension plan’s future, taking preparatory steps today can shorten the implementation timeline,” Scalise says.

Most importantly, “the plan sponsor can determine whether PRT fits the organization’s goals,” Scalise says. “However, the fiduciary duty to participants takes precedence over the company’s bottom line.”

The length of time it takes to complete a pension risk transfer will vary by plan; however, the entire process may take 18 to 24 months, Scalise says. However, even if no immediate action is taken to execute a PRT strategy, plan sponsors can still prepare themselves in case they have to revisit the issue down the road. If the plan sponsor does decide to consider a change, Scalise has a handful of questions to think about before making any moves.

• Who will be on the company’s internal team that will manage the process?
• Will the PRT process include specialty consultants such as actuaries, investment bankers, annuity placement providers, or legal counsel?
• Is the company’s valuation data clean and up to date? Can final accrued benefits be validated, and missing participants located?
• Who will evaluate request for proposal (RFP) responses submitted by the insurers, and ultimately select the annuity provider?
• What would the communication strategy be to senior management, plan participants, retirees, etc.? What about externally to the public and other interested parties?

Rising inflation, the specter of higher interest rates, and the outbreak of war made for a challenging backdrop for investors during the first quarter.

The year began with modest declines across major asset classes in a synchronized sell-off as investors processed a range of significant global crosscurrents. Only commodities moved higher during the quarter, accelerated by supply shocks stemming from the Russian invasion of Ukraine. Normally sedate bond markets were rattled by inflation fears and the beginning of a Federal Reserve tightening campaign.

Figure One: Major Asset Class Returns

Source: Bloomberg. Asset class returns are represented by the following indexes: Bloomberg U.S. Aggregate Bond Index (U.S. bonds), S&P 500 Index (U.S. large-cap stocks), Russell 2000® (U.S. small-cap stocks), MSCI EAFE Index (international developed market stocks), MSCI Emerging Market Index (emerging market stocks), Dow Jones U.S. Real Estate Index (real estate), and Bloomberg Commodity Index (commodities).

• U.S. large-cap stocks declined 4.6 percent during the first quarter despite a strong March rally, as the S&P 500 delivered its first quarterly decline since the first quarter of 2020.
• International stocks fared worse amid fears of energy and commodities shortages. Developed market stocks slipped by 5.8 percent, while emerging markets stocks dropped by 6.9 percent.
• Bond prices retreated as interest rates rose, leading to a 5.9 percent decline in the first quarter, the largest quarterly loss for the Bloomberg U.S. Aggregate Bond Index in more than 40 years.
• The only major category to post gains during the quarter was commodities, as prices for a wide range of inputs—from food to energy and basic materials—surged higher amid higher demand, constrained supply, and the shock of the Russian invasion of Ukraine. The result was the best quarter for commodities since 1990.

The first quarter was a rare instance when diversification felt more like diversi–frustration, as both the S&P 500 and the Barclays U.S. Aggregate Bond indexes suffered simultaneous declines, something that has occurred in just six other calendar quarters over the past 30 years. As shown in Figure Two, when stock prices fall, bonds typically appreciate, providing a counterweight and diversification benefit (see top left quadrant). But during the first quarter, bonds also fell sharply (lower left), leaving investors with few places to hide.

Figure Two: Quarterly Returns for U.S. Stocks and Core Bonds (since 1992)

Sources: Bloomberg, CAPTRUST Research

A World of Two Wars

We entered 2022 with the belief that, following the abnormal economic, market, and policy conditions arising from the COVID-19 pandemic, investors should brace for a return to more normal market conditions, including the higher levels of volatility and market pullbacks that characterize them. Even so, we were surprised by just how quickly volatility returned, beginning the very first week of the year. Even as businesses and consumers continued to recover from the economic consequences of the pandemic, the outbreak of two simultaneous wars introduced new risks and uncertainties: the Russian invasion of Ukraine and the Federal Reserve’s war on inflation.

Unfortunately, the first of these wars is measured in human lives and destroyed cities. The invasion of Ukraine is both a humanitarian nightmare and a conflict that poses significant economic risks to the global economy. And while the second war pales in comparison on a human scale, the consequences of elevated inflation and the policy actions needed to bring it under control have pushed both interest rates and market volatility sharply higher.

Rising Prices Raise Alarms

Even before Russia invaded Ukraine, the U.S. economy was facing levels of inflation not seen since the 1980s due to pandemic-driven supply and demand imbalances and the extraordinary government stimulus used to blunt the economic damage caused by the COVID-19 pandemic.

After climbing steadily in 2021, inflation accelerated this year, with the Consumer Price Index (CPI) touching 7.5 percent in January on its way to a whopping 8.5 percent year-over-year increase in March—the highest reading since 1981. With this level of inflation, it’s no surprise that consumer sentiment has fallen to one of its lowest points in the past 70 years, as rising costs have significantly eroded the benefits of wage gains for many workers.

However, hidden within the March inflation data were some glimmers of hope that the trajectory of inflation could flatten or even decline later this year. Over half of the March increase was driven by an 18 percent spike in gasoline prices within a single month due to the Russian invasion. Oil prices have since moderated from weaker demand due to China’s severe COVID-19 lockdowns and the impact of the largest-ever releases of oil from strategic petroleum reserves.

Other bright spots in the March CPI data: Core price inflation, which excludes the volatile categories of food and energy, rose by a smaller amount, and used car prices posted a significant monthly decline. Vehicle prices are still elevated over pre-pandemic levels and could serve as a continuing source of disinflation as the automobile market normalizes.

An Inflation-Fighting Fed

Figure Three: Consumer Price Index Year-over-Year Change (March 2022)

During the pandemic, as factories were shuttered and supply chains were jammed, massive stimulus payments and lower costs gave people money to spend. This is a clear recipe for higher prices, and the hope was that inflation would fade as pandemic disruptions began to resolve. But as we entered the new year with inflation signals flashing red and the strongest labor market in a half century, the Fed was forced to use its words—also known as Fedspeak and closely scrutinized by analysts—and its policy actions to reduce the inflation threat.

The only way to tamp down inflation is to slow the pace of growth within an economy that’s running full tilt, and the Fed has several tools to do so. The first is raising the federal funds rate, the interest rate that is used for short-term loans between banks. The fed funds rate flows through the financial system into all kinds of business and consumer credit. Higher rates increase borrowing costs, reduce consumer demand and business investment, curtail more speculative activity, and cause the economy to cool.

In mid-March, the Federal Reserve hiked the fed funds rate by 0.25 percent. This represents its first uptick since 2018 and the opening salvo of an inflation-fighting campaign expected to deliver seven or more rate hikes this year. But the minutes of the Fed meeting released several weeks later supply even stronger indications that more aggressive 0.50 percent increases are also on the table. Investors have taken these comments to heart, with the futures markets suggesting a nearly 87 percent probability of a 0.50 percent increase during the Fed’s next meeting in May, according to the CME Group’s FedWatch Tool.

The March meeting minutes also yielded clues about another weapon within the Fed’s inflation-fighting arsenal: quantitative tightening—or reducing the size of its enormous balance sheet of securities purchased during the crisis to inject liquidity into the financial system and keep borrowing costs low. The March minutes suggest that the Fed could begin quantitative tightening as early as May at a pace of up to $95 billion per month.

Bond markets have reacted swiftly to the Fed’s hawkish pivot. Two-year Treasury yields, which are more sensitive to the fed funds rate, leapt from 0.7 percent to 2.3 percent over the course of the first quarter. This rapid rise in short-term yields led to the market condition known as an inverted yield curve, where yields for long-term bonds fall below those of shorter-term bonds. Historically, this condition has been a reliable harbinger of recession.

Figure Four: Spread between 10- and 2-Year Treasury Yields

Sources: Federal Reserve Bank of St. Louis, Strategas, CAPTRUST Research

Although the yield curve inversion at quarter-end was brief, it highlights one of the biggest questions facing investors today: Can the Fed can prove the yield curve wrong by employing its policy tools to engineer an economic soft landing that reduces market excesses and inflation without pushing the economy into recession? This is a hard enough task in a normal market cycle but is greatly complicated by the war in Ukraine, the experimental nature of quantitative tightening, and the lingering effects of a global pandemic.

Economic Impact of War in Ukraine

Russia’s invasion of Ukraine represents, first and foremost, a shocking humanitarian crisis and a threat to global peace and stability. It has also introduced an unpredictable factor to global inflation dynamics, as the production and distribution of key commodities have been interrupted by both the conflict and the financial sanctions imposed to punish Russia’s aggression.

Russia is a major exporter of key industrial and food commodities. It is the second-largest net exporter of crude oil, the fourth-largest provider of natural gas to global markets (which supply much of Europe’s electricity), and the top exporter of fertilizers that are critical to global food production. Perhaps most critically, together Russia and Ukraine export almost 30 percent of the global trade in wheat, as well as other important grains and vegetable oils used in food production, according to the Observatory of Economic Complexity.

In the days following the invasion, prices spiked for a range of energy sources, industrial metals, and food staples. This could amplify inflation pressures in the months ahead and create risks of global food shortages that could trigger political or social unrest. In March, a global food price benchmark compiled by the United Nations rose by nearly 13 percent, reaching the highest level since the index was created in 1990¹.

What Could Go Right?

During a volatile, breaking-news-driven market environment, it is also important to consider what could go right from here. Fundamentals remain in place for investment gains if the trio of macroeconomic risks—inflation, the Fed’s actions to contain it, and the war in Ukraine—can be better understood by investors.

Despite a backdrop of rising uncertainty, U.S. stocks suffered only modest declines during the first quarter, in part because economic and business fundamentals remain strong. Although U.S. companies’ profit growth has slowed due to rising input and labor costs, margins still are well above their long-term averages. Meanwhile, investors have cheered as companies continue to return capital to shareholders.

Companies have two primary ways to return capital to investors: dividends, which are more certain but immediately taxed, and stock buybacks, which can defer taxation but provide a more uncertain future return. Last quarter, buybacks set a record at $270 billion—more than double the pace of the same period in 2020. Companies also set a record for dividends in 2021, returning more than $500 billion to shareholders, according to data service Bloomberg.

And despite rising input and labor costs, high levels of profitability continue to serve as a tailwind for stocks, as strong consumer demand and productivity gains have allowed firms to pass higher input and labor costs along to customers.

More Questions than Answers

Amid this challenging backdrop, investors are hungry for clarity. Based upon our ongoing conversations with clients, asset managers, and other market participants, we believe that some of the most important questions investors face today fall into four categories.

The Russia and Ukraine War

• How extensive will the human, physical, and financial damage from the war in Ukraine be?
• How long will the conflict last, and will it tip Europe into recession?
• How will the conflict impact energy, industrial, and food commodity prices?

Inflation and the Fed

• Are we nearing the point of peak inflation?
• Can an inflation-fighting Fed avoid a policy error and engineer an economic soft landing?

Business Conditions

• Will oil prices rise further and remain higher for longer?
• When will worker shortages resolve?
• Will higher wages and inflation draw workers from the sidelines?
• When will the effects of rising prices offset higher wages and elevated levels of savings, dampen consumer demand, and reduce the ability of companies to maintain profit margins?

The COVID-19 Pandemic

• Will COVID-19 and its economic impacts remain in the background?
• When will global supply chains catch a break?

Given this list of questions, our view remains cautious. However, this doesn’t mean investors should head for the exits to wait for an all-clear. In fact, some of the best days in the markets have historically come during the depths of a crisis, when the all-clear isn’t yet obvious. During volatile markets, investors’ greatest assets are caution and patience, and it is far better to remain invested with a diversified portfolio that is resilient to a wide range of conditions.

¹Alistair MacDonald and Patrick Thomas, “Ukraine War Drives Food Prices to Record High,” Wall Street Journal, April 8, 2022

Seventy percent of nonprofit CEOs believe that for their organizations to achieve their goals, it is very or extremely important that the organizations’ full staff are diverse. However, when asked if they believe their staffs, as they exist today, are very or extremely diverse, an average of only 36 percent agreed. When looking at the diversity of organizations’ board of directors and senior leadership, the numbers are even worse, as shown in Figure One.

Figure One: The Disconnect Between the Importance of Diversity and Actual Diversity

Source: The Center for Effective Philanthropy

The good news is that the country’s third-largest employer, the nonprofit sector, is more than ready for change. In fact, 69 percent of public and private foundations focused on religious, educational, and other charitable missions polled in CAPTRUST’s annual Endowment & Foundation Survey consider diversity, equity, and inclusion (DEI) a priority for their organization.

The fourth annual survey, which includes the perspectives of more than 150 organizations, shows us nonprofits can take action and improve satisfaction around DEI. How? Measure it as intently as any other key performance indicator and keep track of it over time, says James Stenstrom, endowment and foundation director at CAPTRUST.  

Stenstrom says some organizations already track DEI metrics as “a baseline for assessing achievements on cultural and engagement goals across the various demographic segments within their organization.” For example, he says, 71 percent of nonprofits track diversity metrics on the communities they serve. However, at the same time, nearly half of that group does not track the same for grantees.

Meanwhile, nonprofits who quantify DEI metrics are universally more satisfied with the diversity of their board members, staff, communities served, and grant recipients than those who don’t, says Stenstrom. For example, as shown in Figure Two, the percentage of respondents satisfied or very satisfied with the ratio of lesbian, gay, bisexual, transgender, and queer (LGBTQ) staff nearly doubles—and satisfaction with racial and ethnic diversity of board members more than doubles—when diversity metrics are tracked.

Figure Two: Of Those Satisfied or Very Satisfied with Diversity, What Percentage Are Tracking It?

Source: CAPTRUST’s 2021 Endowment & Foundation Survey

Where to Begin

As shown in Figure Three, the DEI issues most important to nonprofits were about race and ethnicity, gender, and culture. Other issues of high importance were related to LGBTQ, socioeconomic status, and education.

Figure Three: What DEI Issues Are Most Important to You?

Source: CAPTRUST’s 2021 Endowment & Foundation Survey

The highest-ranked issues are a good place to start in terms of collecting that data, says Stenstrom, but it is important to make sure that the diversity metrics nonprofits are gathering will help identify priorities and goals, such as assessing your organization’s current culture.

For example, what do power and privilege look like in your organization? Could your organizational norms create barriers for diverse staff, members of the board, and senior leadership? These types of questions can be challenging, but they are an essential first step. Nonprofits may discover that they are not ready to act—that they need deeper metrics to understand areas of concern and opportunity. And that’s okay, says Stenstrom. “Once you understand who you’re speaking to, you can align your initiatives and efforts accordingly.”

Stenstrom offers a few more tips in the way of collecting the best DEI metrics possible. For starters, only ask for the metrics you need. “Never collect information that you do not plan to or cannot use,” Stenstrom says. “People naturally expect you to do something with the information they share with you at your request.”

Additionally, nonprofits will want to customize the questions for the organization and sector and be sensitive about it. “When assessing data like sexual orientation, sometimes it is best to consider deferring to a third, neutral party for more accurate results,” he says.

Many respondents polled in CAPTRUST’s 2021 Endowment & Foundation Survey are taking it one step further and finding their own unique solutions to drive racial and gender equity and inclusion. According to Stenstrom, among those ideas is creating new committees to promote DEI with faculty and staff members, participating in third-party DEI assessments, and updating the code of ethics to include DEI. Other reported initiatives included racial equity task forces, DEI training, and increased research focused on diversity issues.

Supreme Court Sides with Plan Participants in Plan Fees Case

The U.S. Supreme Court decided in favor of plan participants in Hughes v. Northwestern University (S. Ct. 2021). This much anticipated decision had the potential to curtail the increasing volume of excessive fee cases by changing what must be included in a complaint (the initial filings in a lawsuit) to survive a motion to dismiss. Rather, it left longstanding rules in this area unchanged. The allegations in a complaint cannot be conclusory; they must include facts that plausibly suggest an entitlement to relief.

A few years ago, several separate cases were filed against major colleges and universities, making the now familiar claims that they had overpaid for recordkeeping services and investments and improperly managed their plans. Three of these cases were brought in different federal judicial circuits, and each complaint made essentially the same claims.

As is often the case, motions to dismiss were filed in these cases. A motion to dismiss contends—without delving further into the facts—that the complaint does not include sufficient allegations for the case to proceed. In two of these cases, the motions to dismiss were denied and the cases proceeded to litigation. In the third, against Northwestern University, the motion to dismiss was granted, and dismissal was upheld by the U.S. Circuit Court of Appeals for the Seventh Circuit. A key factor relied on by the Seventh Circuit was that, in addition to “expensive” funds, the plan also offered lower-cost index funds. The court reasoned that because lower-cost funds were available to plan participants, it did not matter that other funds may have been too expensive. Also, because recordkeeping fees were paid from revenue sharing, participants could select the less expensive index funds to manage the recordkeeping fees they paid.

With the federal judicial circuits split on what must be included in a complaint to survive a motion to dismiss, the Supreme Court accepted the case. In a unanimous decision, the Court reversed the Seventh Circuit’s decision, rejecting its reliance on the availability of a diverse menu of investments—including less expensive index funds—as basis for dismissing claims that the plan fiduciaries overpaid for investments and recordkeeping. The Supreme Court also noted that its guidance in Tibble v. Edison Int’l, (S. Ct. 2015) was not applied by the lower courts in this case. The Hughes decision will make it easier for plan participants to pursue excessive fee claims in jurisdictions that followed the Seventh Circuit’s overruled approach.

The Supreme Court reiterated key points in Tibble v. Edison Int’l that “a fiduciary normally has a continuing duty of some kind to monitor investments and remove imprudent ones.” “Plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options. If fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breach their duty.” The case was sent back for the lower court to evaluate the sufficiency of the complaint based on Tibble’s guidance.

Perhaps in a nod to the challenges plan fiduciaries face, the Court acknowledged that the appropriate fiduciary inquiry will be context specific, and went on to say, “At times, the circumstances facing an ERISA [Employee Retirement Income Security Act] fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.”

Cybersecurity: DOL Enforces Subpoena Against Provider

We have previously reported on cybertheft lawsuits filed by participants in two plans administered by Alight Solutions. In one case a participant in the Estee Lauder 401(k) plan lost more than $90,000, and in the other case, a participant in the Abbott Laboratories 401(k) plan lost $137,000. The Department of Labor (DOL) began investigating Alight in 2019 because it had received information that:

• Alight made unauthorized distributions as a result of cybersecurity breaches;
• Alight failed to immediately report the cybersecurity breaches to ERISA plan clients after they were discovered; and
• Alight repeatedly failed to restore the unauthorized distributions to participants’ accounts

As part of its investigation, the DOL issued an administrative subpoena to get records from Alight. Alight refused to provide all requested information, and the DOL filed suit so a court could enforce the subpoena. An enforcement order was issued during the fourth quarter of 2021. Walsh v. Alight Solutions, LLC (N.D. IL 2021)

This situation illustrates the attention cybersecurity is receiving at the DOL. It is also reported that the DOL has begun plan audits focusing on cybersecurity practices.

Fee Litigation Continues and Is Impacting the Fiduciary Insurance Market

The flow continues of new cases, decisions, and settlements alleging fiduciary breaches through the overpayment of fees and the retention of underperforming investments in 401(k) and 403(b) plans. These cases are also impacting the fiduciary insurance market. Following is a sampling of this quarter’s developments, including a new challenge to the share classes of investments used.

Share Class Challenge—Juniper Networks, Inc., a high tech firm, has been sued in connection with its 401(k) plan. The case includes the now familiar allegations of overpayment for recordkeeping fees and managed account services. However, it also challenges the plan fiduciaries for not using the net least expensive share classes of the mutual funds in the plan, net of revenue sharing.

In the Juniper Networks case, the plaintiffs are alleging that plan fiduciaries failed to use the net cheapest share classes. That is, there were share classes available that would be less expensive after offsetting revenue sharing, which could be allocated to plan participants or used to pay plan expenses. Reichert v. Juniper Networks, Inc. (N.D. CA 2021)

Other Cases:

• BlackRock Institutional Trust Company—Settlement—Familiar allegations against financial products providers, alleging the use of the firm’s own investments in the plan and payment of excessive fees. Settled for $9.65 million, of which $2.8 million will be paid to plaintiff’s counsel. BlackRock denies any liability. Baird v. BlackRock Institutional Trust Company, N.A. (N.D. CA 2021)
• T. Rowe Price Group—Settlement—Familiar allegations against financial products providers, alleging the use of the firm’s own investments in the plan and payment of excessive fees. In the settlement, T. Rowe Price agreed to offer a self-directed brokerage window and pay a total amount of $13.6 million, $6.6 million of which was paid as a partial settlement in 2019. Up to $3.5 million may be paid to plaintiff’s counsel. T. Rowe Price denies any liability. As of December 31, 2020, the T. Rowe Price plan has assets of $3.9 billion. Feinberg v. T. Rowe Price Group, Inc. (D. MD 2022)
• University of Pennsylvania—Settlement—Familiar allegations against 403(b) plans, alleging the payment of excessive fees and multiple providers, among other things. Settled for $13 million, of which $4.3 million will be paid in attorney’s fees. The University of Pennsylvania denies any liability. On average, 2,097 participants will receive $375 each. Approximately 2,000 participants will receive more than $1,000. Sweda v. The University of Pennsylvania (E.D. PA 2021)

Fiduciary Insurance Impacts—The high volume of fee cases, many of which have been settled, has reportedly resulted in increased premiums for fiduciary coverage, and that coverage is now frequently coming with higher retentions (deductibles), in the millions of dollars. It is increasingly common for the renewal and underwriting of this coverage to include a questionnaire asking about a plan’s inclusion of indexed funds and efforts to control costs.

Intel Wins Target Date Fund Case on Motion to Dismiss

As previously reported, Intel’s 401(k) plan used a custom target date fund solution that included a significant amount of hedge fund investments. Plan fiduciaries were challenged for using hedge funds because their performance and high fees were a significant drag on performance as compared to the performance of target date funds that did not use hedge funds. The district court had previously dismissed the claim because the complaint did not include enough detailed factual support. The plaintiffs were allowed to file an amended complaint, but it also fell short. Finally dismissing the case, the judge pointed out:

• A complaint cannot simply make a bare allegation that costs are too high or returns are too low;
• An allegation that a fund is mismanaged must be fact-specific because there is no one-size-fits-all approach to investing;
• Without presenting a meaningful benchmark, the court cannot evaluate if an alleged violation of the duty of prudence is plausible; and
• ERISA fiduciaries are not required to adopt a riskier strategy simply because that strategy may increase returns. (In this case, the challenged hedge funds dampened risks and returns.)

The judge had previously noted the following:

• The ERISA prudence standard focuses on a fiduciary’s conduct in arriving at an investment decision, not on its results, and asks if a fiduciary employed the appropriate methods to investigate and determine the merits of a particular investment.
• On its own, the failure to select the investment with the lowest fees is not sufficient to plausibly state a claim for breach of the duty of prudence.

Anderson v. Intel Corporation Investment Policy Committee (N.D. CA 2021, 2022).

Annual Plan Financial Statement Audit Changes

Changes are coming to the annual plan financial statement audit that is required for all plans with more than 100 participants. This is the audit performed by a qualified accountant and filed with the plan’s annual Form 5500. The American Institute of Certified Public Accountants (AICPA) adopted a new auditing standard for retirement and other employee benefit plans known as SAS No. 136. It applies to plan years ending after December 15, 2021.

• The limited-scope audit, which is utilized by many retirement plans, is being replaced by ERISA 103(a)(3)(c). The basic idea of a limited-scope audit that relies on data from a “qualified institution” is still available. However, the plan sponsor will be required to certify that the trustee or custodian is a qualified institution. It is anticipated that plan recordkeepers will provide support for this certification.
• The roles and responsibilities of each party (e.g., plan sponsor, auditor) will be clarified and documented as part of the audit process.
• Auditors may be more likely to find and disclose errors and other reportable findings.

Plan sponsors should expect the retirement plan audit processes to be different, with additional data and representations required by plan auditors and more detailed reporting back from auditors.