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401(k) Plan Fiduciary: How You Can Mitigate Your Risk

Fiduciary responsibilities can seem daunting and time-consuming. Learn the ins and outs of your responsibilities and which ones you can delegate.

Articles by Betterment Editors
By the Editorial Staff Betterment Resource Center Published Mar. 03, 2020
Published Mar. 03, 2020
7 min read

You probably know that to compete in attracting new talent and retaining your best employees, a 401(k) plan has become a “must-have” benefit.

Sponsoring a 401(k) plan, however, comes with both administrative and investment responsibilities. If not managed properly, these duties can be a distraction that not only takes precious time away from building your business, but can also create legal risks for you and your company.

If you are just starting a 401(k) plan, make certain you understand which services will be performed by whomever you hire to administer your plan and which retirement plan tasks fall to you.

A Brief History of the 401(k) Plan and Fiduciary Duties

When Congress passed the Revenue Act of 1978, it included the little-known provision that eventually (and somewhat accidentally) led to the 401(k) plan. The Employee Retirement Income Security Act of 1974, referred to as ERISA, is a companion federal law that contains rules designed to protect employee savings by requiring individuals and entities that manage a retirement plan, referred to as “fiduciaries,” to follow strict standards of conduct.

Fiduciaries must always act in the best interests of employees who save in the plan. When you adopt a 401(k) plan for your employees, you become an ERISA fiduciary. And in exchange for helping employees build retirement savings, you and your employees receive special tax benefits, as outlined in the Internal Revenue Code.

The IRS oversees the tax rules, and the Department of Labor is the government agency responsible for providing guidance regarding ERISA fiduciary requirements and for enforcing these rules. Just like the laws and regulations that you must follow in operating your business, the tax laws and ERISA can feel like navigating a maze, with lots of twists and turns. But engaging skilled 401(k) service providers will help reduce the confusion and the burden of your retirement plan duties.

Even 401(k)s of Small Businesses Come with Fiduciary Responsibilities

By sponsoring a retirement plan, you take on two sets of fiduciary responsibilities. First, you are considered the “named fiduciary” with overall responsibility for the plan, including selecting and monitoring plan investments.

You are also considered the “plan administrator” with fiduciary authority and discretion over how the plan is operated. Most companies hire one or more outside experts (such as an investment advisor, investment manager or third party administrator) to help them manage their fiduciary responsibilities.

5 Cornerstone Rules You Must Follow

As a fiduciary, you must follow the high standards of conduct required by ERISA both when managing your plan’s investments and when you are making decisions regarding plan operations. There are five cornerstone rules you must follow as an ERISA fiduciary.

  1. Each decision you make regarding your plan must be based solely on what is best for your employees who participate in the plan, and their beneficiaries.
  2. You must act prudently. Prudence requires that you be knowledgeable about retirement plan investments and administration. If you do not have the expertise to handle all of your responsibilities, you will need to engage professionals who have that expertise such as investment managers or recordkeepers.
  3. You must diversify investments to the extent needed to reduce the risk of large losses to plan assets.
  4. You must follow the terms of the plan document when operating your plan.
  5. Fees from plan assets must be reasonable and for services that are necessary for your plan. There are detailed DOL rules that outline the steps you must take to fulfill this fiduciary responsibility including collecting fee disclosures for investments and service providers and comparing (or benchmarking) the fees to make certain they are reasonable.
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Fiduciary Responsibilities are Serious Business

Fiduciary responsibilities should not be taken lightly. Employees who participate in the plan, as well as other plan fiduciaries, have the right to bring a lawsuit to correct fiduciary wrongdoing. The DOL also has the authority to enforce the rules through civil and criminal actions. Not only can the cost of governmental penalties associated with enforcement be high, but the costs associated with fixing the problem can also be significant. These normally involve legal, accounting, and other fees.

Under ERISA, fiduciaries are personally liable for plan losses caused by a breach of their fiduciary responsibilities and may be required to:

  • restore plan losses (including interest), and
  • pay the expenses relating to the correction of inappropriate actions.

While the list of fiduciary responsibilities from above can seem daunting, the good news is that ERISA also allows you to delegate many of your fiduciary responsibilities to 401(k) professionals.

Hiring 401(k) experts to manage your plan investments and operations can be a fiduciary decision. This means you should make the decision carefully. Even though you can appoint others to carry out most of your fiduciary responsibilities, you can never fully transfer or eliminate your role as an ERISA fiduciary. You will always retain the fiduciary responsibility for selecting and monitoring the investment professionals and administrators for your plan.

How much responsibility you retain and how much will be handled by the outside expert will vary depending upon the level of fiduciary responsibility provided by the entities you select. This is especially true when selecting investment professionals to support the 401(k) plan.

For purposes of this article, we will focus primarily on investment support services since that is often the most challenging aspect of 401(k) plan oversight for employers. This also typically poses the greatest regulatory and legal risk.

Different Levels of Investment Support

In most 401(k) products, you, as the plan fiduciary, are responsible for selecting and monitoring the investments that will be available to your employees through the plan. A growing number of employers have become the target of lawsuits alleging violations of fiduciary duty by selecting poor- performing or more expensive investments compared to comparable investments.

For most employers, day-to-day business responsibilities leave little time for extensive investment research and analysis, including fee benchmarking. Many companies hire outside experts to take on the fiduciary investment duties. As outlined in the table below, the degree of investment fiduciary responsibility assumed by the outside experts can vary greatly, which has implications for you as an employer.

Defined in ERISA Section Outside Expert Employer
n/a Disclaims any fiduciary investment responsibility Retains sole fiduciary responsibility and liability
3(21) Shares fiduciary investment responsibility in the form of investment recommendations Retains responsibility for final investment discretion
3(38) Assumes full discretionary responsibility Relieves employer of investment fiduciary responsibility

Delegating All of Your Investment Responsibilities

The decision to hire an investment manager is a fiduciary function. However, once appointed, a 3(38) investment manager will take on the following duties below, moving them off your to-do list.

  • Development of an investment policy statement (IPS) that defines the strategic objectives for the plan’s investments and the criteria that will be used to evaluate investments.
  • Creation of the due diligence process for selecting and monitoring investments for your 401(k) plan.
  • Monitor investment performance against the criteria outlined in the IPS and replace investments when an investment does not perform well or when comparable investments with lower fees become available.

When you appoint an ERISA 3(38) investment manager, you have fully delegated responsibility for selecting and monitoring plan investments to the investment manager. Your obligation is to prudently select the investment manager—ensuring they have the credentials and track record to support your plan—and to make certain they are meeting their duties.

Responsibilities You Can’t Delegate

Because selecting an ERISA 3(38) investment manager and delegating your investment responsibilities provides a significant reduction in your fiduciary responsibilities, ERISA requires that you monitor their work.

On a regular basis, carefully review the reports provided by any outside investment experts you hire. In addition to reviewing your plan’s investment performance and fees, you should also identify any issues that arose with respect to investment support. For example:

  • Were there any participant complaints or concerns regarding investment services? If so, were all issues addressed timely and appropriately?
  • Were there any interruptions in participants’ access to investment tools or resources?

A more formal and in-depth review of the plan’s outside experts should be conducted periodically to ensure that they are meeting your organization’s needs. Items to consider include:

  • Business Structure: Have there been any changes in business structure or licensing that impact the investment management services being delivered to your plan?
  • Litigation or Regulatory Enforcement: Have there been any recent litigation or regulatory enforcement actions that have been taken against the firm?
  • Modifications in Services: Evaluate notices received from the service provider or changes in practices that have occurred since they were retained. Do these changes impact the level of service you were seeking from the service provider?
  • Staffing Changes: Have there been changes in the staff assigned to support your plan or in the team that manages your plan’s investments? Could the changes have a negative impact on the services provided to your plan?
  • Reasonable Fees: Review the investment fees during the plan year to ensure they were reasonable. Did the actual fees charged match the fees set forth in the service agreement? Do the fees still benchmark favorably against fees charged by other service providers for similar services?
  • Employee Engagement: How many employees have set both short-term and long-term savings goals? How many have provided sufficient demographic information to personalize their savings goals?

The Bottom Line on Being a 401(K) Fiduciary

Sponsoring a 401(k) plan comes with a complex set of responsibilities, but prudently selecting the right team of outside experts, especially when it comes to investments, can help you manage your responsibilities and potential liability.

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