Court rulings on issues involving the Employee Retirement Income Security Act sometimes have surprising outcomes, and a June decision from the U.S. District Court for the District of Massachusetts in the case of DeBold v. Liberty Life Assurance Co. of Boston[1] is a good example.

The issue in the case involved the question of whether retirement benefits transferred directly into a rollover account could be offset against the plaintiff’s ERISA-governed disability insurance benefits.

Although the rollover was not considered receipt of the funds for tax purposes, the court upheld the insurer’s finding that the funds Jami DeBold received reduced her disability payments.

Group long-term disability benefit policies typically contain coordination of benefits provisions that reduce disability payments by the amount conferred by other benefits that provide income to the insured during a period of disability and are viewed as duplicative of disability insurance benefits.

Examples include Social Security disability payments and workers’ compensation payments. Defined contribution benefits such as 401(k) benefits are usually, but not always, exempted.

Other types of retirement benefits that are funded by employers can offset disability benefits if they are received by the employee while disability benefits are being paid.

However, such benefits are a form of deferred compensation, and, if distributable prior to normal retirement age, the timing of the distribution of such benefits is usually within the control of the employee.

Hence, the employee may choose to defer the payments to a date after disability benefits expire, which is typically age 65 or the normal Social Security retirement age (age 67 for most current employees).

In order for employees to have more control over the disposition of their retirement benefits under both 401(k) plans and even defined benefit retirement plans that permit employees to receive a lump-sum distribution, the tax code permits employees to establish a rollover account to receive funds via a trustee-to-trustee transfer in order to preserve the tax-deferred status of the funds.

When an employee establishes an IRA rollover account, the transfer of funds directly into such an account means the employee does not immediately receive the funds, and the tax-sheltered retirement benefits are taxable only when they are actually distributed to the employee.[2]

In cases that preceded DeBold, several courts addressed whether funds withdrawn from a retirement account reduce a disability insurance benefit recipient’s benefit. Most of the rulings have determined that so long as there is a direct trustee-to-trustee transfer of retirement funds, an offset would be improper.

The leading case on this issue is Blankenship v. Liberty Life Assurance Co. of Boston,[3] decided in 2007 by the U.S. Court of Appeals for the Ninth Circuit. The court held that so long as the funds are transferred directly into and then maintained in a rollover account without any withdrawals, there is no constructive receipt.

Other cases have come to the same conclusion.[4]

However, in 2012, in Day v. AT&T Disability Income Plan,[5] the Ninth Circuit held to the contrary based on the plan administrator’s discretionary authority in interpreting plan provisions.

In DeBold, the court ruled the same way as in Day.

Jami DeBold was originally employed by First Union, which merged with Wachovia Corp. and subsequently with Wells Fargo & Co., and her disability benefit coverage was through the Wachovia plan.

While covered by the plan, in December 2001, DeBold was severely injured in an accident and rendered a quadriplegic.

DeBold’s disability claim was approved; however, her benefits were reduced after she withdrew approximately $100,000 from her employer’s cash balance pension plan, transferring the funds directly into a rollover account.

Although the plaintiff maintained the funds did not constitute income to her, the plan administrator disagreed.

After DeBold filed a lawsuit to challenge the offset, the plan moved for dismissal.

Applying a deferential standard of review, the court granted the plan’s motion to dismiss the complaint after finding that the facts alleged did not “plausibly [suggest] that the reduction in her long term disability benefits was arbitrary and capricious or an abuse of discretion.”

The plaintiff maintained that even if the plan language permitted the reduction, it was unenforceable because it was contrary to the tax code.

The court disagreed, pointing out:

Even if Ms. DeBold is correct that her rollover was a non-taxable event and that ERISA does not control IRAs, she has failed to articulate why those facts would render Wells Fargo’s decision to uphold the reduction in her benefits arbitrary and capricious or an abuse of discretion.

The court further explained:

Whether her rollover had tax consequences is distinct from whether it had consequences to her long term disability benefits under the terms of the Wachovia Plan. Federal income tax and ERISA are two separate areas of law, and ERISA plans are not reviewed or interpreted based on the tax laws. An ERISA plan is essentially a contract,[6] and ERISA plans are therefore typically reviewed in accord with contract principles. Ms. DeBold has identified no principle of contract law or interpretation that suggests that the relevant portions of the Wachovia Plan—which she concedes authorized Wells Fargo to reduce her long term disability benefits following the rollover—are invalid or unenforceable because they resulted in a change in benefits even where there were no tax consequences.

This ruling is completely at odds with Blankenship, which observed:

Because [Blankenship] had the same type of possession (and control) of the funds once transferred into the Vanguard account that he would have had were the funds left with KPMG, he did not ‘receive’ these funds for the purposes of offset under the Disability Plan.[7]

The court in DeBold based its decision on ambiguous plan language defining the meaning of a “retirement plan,” and maintained that the summary plan description explicitly stated that an IRA rollover constituted a distribution.

However, the summary plan description is not the plan document, and allowing a plan administrator to offer an interpretation of a benefit plan that runs afoul of the tax code and the purpose behind a trustee-to-trustee transfer is hardly consistent with Congress’ paternalistic purposes in enacting the ERISA statute.

The court’s ruling also eviscerated the intent behind a disability benefit plan, which provides financial support during a period of disability that occurs during what otherwise would be working years, and is thus distinct from the intent behind a retirement plan, which funds a worker’s retirement years with compensation deferred during their working years.

There are two critical lessons taught by this ruling.

The first is the critical importance of the judicial standard of review. The difference between the Blankenship and Day rulings was that the former was decided under the de novo standard, while the latter was decided under the arbitrary and capricious standard of review.

Had DeBold been decided without deference being given to the plan administrator, the outcome almost certainly would have been different.

But even under a deferential standard of review, the court is not supposed to act as a rubber stamp.

One of the best articulated guidelines explaining how cases are to be decided under an abuse of discretion review is the U.S. Court of Appeals for the Fourth Circuit’s 2000 ruling in Booth v. Wal-Mart Stores Inc. Associates Health and Welfare Plan,[8] which requires a court to examine the decision made in light of the following factors:

1) the language of the plan; (2) the purposes and goals of the plan; (3) the adequacy of the materials considered to make the decision and the degree to which they support it; (4) whether the fiduciary’s interpretation was consistent with other provisions in the plan and with earlier interpretations of the plan; (5) whether the decision making process was reasoned and principled; (6) whether the decision was consistent with the procedural and substantive requirements of ERISA; (7) any external standard relevant to the exercise of discretion; and (8) the fiduciary’s motives and any conflict of interest it may have.

Although DeBold was decided by a court in the First, rather than the Fourth, Circuit, the principles enunciated in Booth are derived from the Restatement of Trusts and have universal applicability.

The plan’s interpretation is inconsistent with the plan’s goals — while the offset provisions are aimed at preventing double-dipping, that is not what DeBold was doing, since her apparent intent was to preserve her retirement benefits but exercise greater control over how the funds were invested.

The plan’s interpretation in DeBold was also contrary to a well-recognized external standard: the Tax Code, under which DeBold did not formally receive the monies at issue.

Just because a benefit plan can interpret the plan in the way it did in this case does not mean that such an interpretation is reasonable, since it had the effect of depriving DeBold, a quadriplegic, of significant financial resources — the disability benefits she was entitled to receive on account of her disability that were subject to reduction only if she received other income that overlapped with her disability benefits.

The second lesson taught by DeBold is that it was not a one-off situation. The fact that other courts have ruled on the same issue suggests that this issue may arise with a degree of frequency.

Plan administrators have fiduciary obligations imposed by ERISA, and such obligations impose an affirmative obligation to notify plan participants of issues that may affect their entitlement to benefits regardless of whether they make inquiry.[9]

If the plan intended to offset retirement benefits directly transferred to a rollover account, it should have said so clearly and unmistakably so that DeBold would have known before she made an irrevocable decision that ended in financial harm.

Disability benefit plans should warn recipients who may be contemplating transferring funds out of a retirement account that they do so at their own risk, and they should be asked to affirmatively acknowledge that risk so that the situation in DeBold never occurs again.


Mark D. DeBofsky is a shareholder at DeBofsky Sherman Casciari Reynolds PC.

This article was first published in Law360 on July 14, 2021.

[1] DeBold v. Liberty Life Assurance Co. of Boston, 2021 U.S. Dist. LEXIS 120153, 2021 WL 2646677 (D. Mass. June 28, 2021).

[2] See, e.g., 26 U.S.C. §§ 401(a)(31)(A), 402(e)(6), 408(a)).

[3] Blankenship v. Liberty Life Assurance Co. of Boston, 486 F.3d 620 (9th Cir. 2007).

[4] Neiheisel v. AK Steel Corp., 2008 U.S.Dist.LEXIS 5907 (S.D.Ohio January 17, 2008); Thomason v. Metro. Life Ins. Co., 165 F.Supp.3d 512 (N.D. Tex. February 25, 2016); aff’d Thomason v. Metro. Life Ins. Co., 703 Fed. App’x 247 (5th Cir. July 18, 2017)(Non-precedential).

[5] Day v. AT&T Disability Income Plan, 685 F.3d 848 (9th Cir. 2012).

[6] Citing US Airways, Inc. v. McCutchen, 569 U.S. 88, 100–02 (2013).

[7] 486 F.3d at 627.

[8] Booth v. Wal-Mart Stores Inc. Associates Health & Welfare Plan, 201 F.3d 335, 342-343 (4th Cir. 2000).

[9] See, e.g., Eddy v. Colonial Life Ins. Co. of Am., 919 F.2d 747, 750, 287 U.S. App. D.C. 76 (D.C. Cir. 1990).

 

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