Excerpted from The Biggest Legal Mistakes Physicians Make: And How to Avoid Them

Edited by Steven Babitsky, Esq. and James J. Mangraviti, Esq. (©2005 SEAK, Inc.)

Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them

Executive Summary

In today’s competitive work environment, many physicians are expected to provide their employees with a number of perks and benefits. However, very few physicians realize that, for the most part, providing perks and benefits to employees is governed by a complex body of law known as ERISA (the Employee Retirement Income Security Act of 1974), which has wide-ranging consequences for the average physician. The purpose of ERISA’s enactment was to develop guidelines for administering retirement plans and other benefit arrangements so that the interests of participants and beneficiaries would be safeguarded. In effect, ERISA was designed to ensure that those entitled to pensions and benefits can collect them.

Generally, ERISA governs the offering and maintenance of all types of retirement plans, including 401(k), profit-sharing, pension, cash balance, and employee stock ownership plans (ESOPs). It also covers welfare plans, which include plans that provide—through the purchase of insurance or otherwise—medical, surgical, or hospital benefits; benefits in the event of sickness, accident, disability, death, or unemployment; vacation benefits; apprenticeship or other training programs; day-care centers; scholarship funds; prepaid legal services; and severance plans in certain instances. Physicians who err by not getting the qualified legal help they need upfront in establishing and implementing these arrangements could face penalties from government agencies and unexpected exposure to liability under ERISA.

Mistake 1        Implementing Benefits Programs Based on “Free” Advice

Physicians often rely on advisers when it comes to establishing, implementing, and maintaining benefit programs for their employees. They need to realize, however, that much of the “free” advice they receive from advisers could be colored by those advisers’ pecuniary incentive in the physicians’ implementation of the arrangement and can sometimes overlook the legal nuances surrounding the benefit arrangement. Moreover, such advisers are generally not trained in the complicated laws and regulations under ERISA, and they are limited in their knowledge. A case in point involves the author’s experience with a client who had been told by multiple advisers that she could engage in certain action with respect to her 401(k) plan. When the author advised her that the action was not permissible under governing laws, she went back to the advisers, who then admitted that they had made a mistake. The client was saved from suffering the expensive legal consequences of a bad decision by seeking the advice of ERISA legal counsel. 

Action Step     Before relying on the advice of an adviser in implementing and maintaining a benefit program, physicians should seek the counsel of their attorney to make sure that it comports with ERISA laws and regulations.

Mistake 2        Having an ERISA Plan Without Knowing It

Often, physicians implement a benefit arrangement (health plans, life insurance plans, disability plans, etc.) in their practice without realizing that the plan they have established is subject to ERISA. In some cases, an option is available as to whether the plan can be structured so that it falls under ERISA. It may sometimes be beneficial for the practice to characterize a benefit plan as an ERISA plan; in other cases, it may be more advantageous if the arrangement is structured so that it falls outside the scope of ERISA. Either way, it is important to know whether the plan is subject to ERISA in order to comply with the laws governing the plan, such as reporting and disclosure requirements, fiduciary standards, and documentation requirements. It is also important because ERISA can sometimes impose harsh penalties on those who ignore its mandates.

Action Step     Physicians should, with the assistance of counsel, make sure they understand which benefit plans are subject to ERISA and what options exist for structuring a desired plan subject to, or outside the scope of, ERISA.

Mistake 3        Not Having Proper Plan Documentation in Place

It is not uncommon to find that physicians do not have the proper documentation in place pertaining to their ERISA plans. ERISA generally imposes two basic documentation requirements on plans that are subject to it: the actual plan must be governed by a written plan document; and participants and beneficiaries of the plan must be given a summary of pertinent plan provisions, including a description of their rights under ERISA, in what is referred to as a “Summary Plan Description.” Many physicians are not careful about having their plans reviewed by legal counsel, and therefore do not have the proper documentation in place to comply with ERISA.

Action Step     Physicians should determine whether benefit arrangements are properly documented and make sure that all documents are properly adopted, executed, and implemented. Also, benefits and ERISA laws frequently change, through congressional action and/or governmental agency regulations. Attorneys who are engaged to represent physicians should make sure that the physicians are apprised of any changes in the law that could affect plan documentation after implementation. Physicians should also make sure that any amendments to the plan are also properly adopted, executed, and implemented. Those who audit ERISA plans often find that intended plan amendments were never prepared or adopted, even though they were implemented. 

Mistake 4        Failing to Deposit Employee Contributions Into a 401(k) Plan Promptly

Physicians who maintain a 401(k) plan and allow their employees to make contributions to the plan often do not realize that once the money is deducted from the employee’s paycheck, the money must be transferred promptly into the plan. Failure to do so can subject physicians to fiduciary liability under ERISA, prohibited transaction excise taxes, and a 20% penalty imposed by the U.S. Department of Labor (DOL), the agency that oversees the implementation of ERISA. In fact, DOL has made this issue a top priority when a plan is audited. DOL states on its website that failure to segregate and forward participant contributions to a plan from the general assets of the employer in the time frames prescribed would result in a prohibited use of plan assets in violation of ERISA. In addition, if a physician’s plan is subject to the plan audit requirements, plan auditors must now determine whether the physician employer has been meeting this requirement and answer accordingly on the plan’s IRS Form 5500. The rule is that the money must be deposited into the plan no later than the earliest date on which such contributions can reasonably be segregated from the employer’s general assets. In one example in the DOL regulations, the reasonable time frame was only two business days. Similar rules apply to other benefits arrangements as well, such as health and other welfare plan contributions.

Action Step     Physicians or their practice managers should work with staff to ensure that 401(k) and other participant contributions deducted from employee wages are deposited as soon as possible into the appropriate accounts. If delays occur, physicians should seek advice about correcting the error under DOL’s Voluntary Fiduciary Compliance Program.

Mistake 5        Administering Retirement Plans and Investing Plan Assets Without Understanding and Complying With ERISA

Physicians often maintain a 401(k) plan, profit-sharing plan, or other pension plan for the purpose of accumulating retirement assets for themselves as well as for their employees. Often, highly trained attorneys, consultants, and actuaries may be involved in complex plan designs for physicians and their practices. However, when it comes to administering the plans and investing the assets, many times physicians serve as trustee of the plan(s) or on the plan committees that administer the plan(s) and direct the investment of plan assets. Frequently, physicians who do so are unaware that they are, by virtue of the functions they perform, deemed to be “fiduciaries” under ERISA. Moreover, even those who are aware they are fiduciaries are often untrained and ill advised about their duties and obligations under ERISA. What many physicians fail to realize is that they are personally liable (meaning that personal assets are at stake) if they breach their fiduciary duties under ERISA and are sued by employee participants for losses incurred as a result of the breach.

Action Step     No physician should be involved in administering or investing the assets of retirement plans without understanding his or her duties and obligations under ERISA. Plan documents can be drafted to minimize liability, physicians can be covered by fiduciary liability insurance policies, and experts can be used to make sure physician follow “prudent processes” with respect to the duties they assume in connection with the administration of retirement plans. Above all, physicians should document the processes being employed in fulfilling their obligations under ERISA.

Mistake 6        Not Having Fiduciary Liability Insurance in Place for Plan Fiduciaries

As mentioned in Mistake 5, physicians often serve as plan fiduciaries for their retirement plans. Many times, they have the fiduciary bonding in place that is required by ERISA. (ERISA requires all fiduciaries and other persons who handle plan assets or funds to be bonded in order to protect the plan and participants against loss from fraud or dishonesty.) However, physicians may be unaware that they can also purchase fiduciary liability insurance to protect themselves from liability due to a breach of fiduciary duty or plan administration error. Although hiring the necessary experts to help them fulfill their duties under ERISA can go a long way toward insulating physicians from personal liability, purchasing fiduciary liability insurance should be an added step in protecting their personal assets in the event an unforeseen turn of events creates exposure to liability under ERISA.

Action Step     Physicians should determine whether they serve as fiduciaries under ERISA. If they do, they should seek to have fiduciary liability insurance in place to protect them in the event of allegations of fiduciary breach and/or negligent plan administration. ERISA counsel should negotiate the terms of the liability policy with the physicians’ insurer to make sure that it adequately protects them from liability.

Mistake 7        Unknowingly Entering Into “Prohibited Transactions” Under ERISA

Imagine this scenario: A group of physicians who serve as trustees for their profit-sharing plan decide to purchase property that will serve as medical office space for their practice. They further decide that their profit-sharing plan will make a loan to the practice, which will then purchase the land and the building. The practice will then make payments on the loan, which will include a favorable interest rate, and the plan will take security for the loan in the property. The physicians believe this will be a good deal for the plan, since they will pay an interest rate equal to rates charged under similar circumstances by lending institutions. Also, they would rather pay interest to the plan than to an unrelated third party. The physicians decide to implement the transaction. Have they done anything that violates ERISA?

Unfortunately, yes. The physicians, as fiduciaries for the ERISA-covered plan, have just caused the plan to enter into a “prohibited transaction,” a complicated ERISA term denoting a transaction between the plan and a party related to the plan (here the employer). While it may in the end be a good deal for the plan, the physicians will now owe significant excise taxes on the transaction. If the prohibited transaction relates to the leasing of property, the lending of money, or other extension of credit, the transaction will generally be treated as giving rise to a prohibited transaction on the date the transaction first occurs, plus multiple prohibited transactions on the first day of each taxable year thereafter until the prohibited transaction is corrected.

Action Step     Physicians should be wary of any transaction that involves sales, loans, leases, exchanges, or other transfers of plan assets to, with, or from parties related to the plan in some way (i.e., the employer, the shareholders or owners of the practice, employees, and service providers). Physicians should also stay away from transactions using plan assets that personally benefit them or individuals related to them in some way. If such transactions are seriously contemplated, physicians should seek advice first. The good news is that there is sometimes a way they can enter into such a transaction without violating the law; that is, by making application for an individual prohibited transaction exemption with DOL and instituting the transactional safeguards required by DOL for the granting of such an exemption.

Mistake 8        Reducing Staff for the Wrong Reasons

The cost to physicians of providing health care and pension benefits for their employees can be daunting when combined with the other rising costs of a medical practice. Physicians often believe they must make changes to their staff to control the costs of such benefits. Very few physicians are aware of the legal pitfalls involved in the process of making such decisions. ERISA prohibits an employer from discharging an employee for the purpose of interfering with the attainment of any right to which the employee may become entitled under an ERISA plan. Courts have held that such practices as terminating employees based on benefits cost to the employer, outsourcing work to an outside contractor to lower benefits cost, or changing the status of an individual from “employee” to “independent contractor” for such purposes have violated ERISA.

Action Step     Physicians should have a bona fide business reason for the change in staff other than reducing benefits cost. They should document the business reason in advance of the staff reduction and proceed with the change only after seeking the advice of an attorney.

Mistake 9        Structuring a Long-Term Disability Plan as an ERISA Plan

One type of benefit program that needs to be structured in such a way that it is not covered by ERISA is the long-term disability plan. There has been a spate of news articles reporting how ERISA is being used as a legal shield, creating difficulties for disabled physicians and others to succeed in valid claims for disability. It seems unbelievable that a statute designed to make retirement plans and other benefits secure under the law is being used to accomplish a different result. However, due to the complex procedural aspects of ERISA as well as interpretation by courts, many of these insurance policies have been weakened. Disability insurance policies can be purchased on an individual basis, or if purchased on a group basis, can be structured in such a way that ERISA does not apply. If ERISA does not apply, the likelihood of recovery for physicians and their employees in the event of incurring a disability is much greater.

Action Step     Physicians should make sure that any long-term disability policy is structured so that it is not covered by ERISA. Such plans will not be covered by ERISA if they are purchased on an individual basis. However, plans that are purchased on a group basis will also not be covered by ERISA if they meet four requirements: (1) no contributions are made by the employer; (2) participation is completely voluntary for employees; (3) the sole functions of the employer with regard to the insurance program are—without endorsing the program—to permit the insurer to publicize the arrangement to the employees and to collect premiums from the employees through payroll deductions and remit them to the insurance company; and (4) the employer receives no consideration in connection with the program except reasonable expenses.

Mistake 10      Not Taking ERISA Seriously

Some physicians and their advisers have ignored the requirements of ERISA, particularly with respect to a small practice, thinking that no one will ever complain and that government agencies are lax with respect to enforcement. However, there are many reasons physicians should take ERISA seriously, including the following:

  • Physicians should understand that the number of Internal Revenue Service (IRS) and DOL audits is rising; the agencies have publicly stated that they are strengthening enforcement initiatives and are sending more agents out on examination. Moreover, if IRS agents discover benefits programs to be amiss, they can refer the cases to DOL, the agency responsible for enforcing ERISA requirements.
  • Noncompliance with ERISA can unnecessarily expose physicians to liability from lawsuits brought by disgruntled employee participants.
  • Physicians are often involved in mergers with other practices or acquisitions by other practices. Astute attorneys representing the buyer will want to have representations that the physicians have complied with ERISA and will ask for disclosures of items where the physicians have failed to comply with ERISA. A history of ERISA compliance failures could affect the price that the physicians might negotiate for sale of the practice, since failure to comply with ERISA creates liability exposure that acquiring entities do not generally want to assume.

Action Step     Physicians should take ERISA seriously when it comes to establishing and implementing their benefit programs for employees. If they feel that they have not had adequate advice about compliance with ERISA, a good step toward compliance would be to hire ERISA counsel to perform a compliance audit of all benefit plans. (It is important that legal counsel be involved to protect any information uncovered by attorney-client privilege.) Keeping benefits programs compliant with ERISA will help ensure that, in the event of a DOL or an IRS audit, participant lawsuits, or mergers or acquisitions involving the medical practice, the physicians are not penalized or exposed to undue liability for failure to comply.


Physicians adopting and implementing benefit arrangements for their employees should be mindful that often there are ERISA requirements that must be met with respect to these benefit programs. Failure to comply with ERISA could subject physicians to unwanted excise taxes and penalties, exposure to personal liability, and difficulties when selling or merging a medical practice. Also, there may be options with advantages and/or disadvantages for structuring a benefit offering so that it is either covered, or not covered, by ERISA. Physicians should explore these options with their ERISA legal counsel.

Written by:

B. Janell Grenier, Esq.

Peer reviewed by:

James C. Bailey, Esq.

Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them