Understanding and fulfilling your fiduciary responsibilities are crucial to managing risk.
Why is meeting fiduciary responsibilities important?
Proactive, informed management of 401(k) plans—and meeting fiduciary responsibilities—often results in lower plan costs, better investment returns, and ultimately employees not delaying retirement due to lack of adequate savings.
Meeting fiduciary responsibilities is also crucial to avoid being sued by your employees or, more importantly, terminated employees. Under the Employee Retirement Income Security Act (ERISA), the federal law that governs retirement plans, any plan fiduciary who breaches any of their responsibilities, obligations, or duties is personally liable to make good on any losses to the plan resulting from the breach. The stakes are high. Fiduciaries who make mistakes are held accountable to restore lost profits and are subject to other “equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary.”
Given the complexity of sponsoring a 401(k) plan, falling short on fiduciary responsibilities is easy to do and doesn’t necessarily involve unethical behavior or gross negligence. Not reviewing your plan frequently enough or failing to document decisions can lead to a breach. Having a comprehensive checklist that also acts as the central repository of the schedule, timing, and completion of processes and to ensure complete coverage of retirement plan compliance best practices is essential to proper documentation.
Who is a fiduciary?
A fiduciary is an individual or organization identified by the plan as a “named fiduciary” or an individual who performs certain activities. It is important that those working with their companies’ retirement plans know whether their job functions hold them to a fiduciary standard of care or whether they are simply performing settlor functions.
Retirement plan fiduciaries typically hold positions within the human resources or finance departments within their organizations, but may also include the company’s CEO or owner. ERISA identifies several activities performed by those considered to be a fiduciary regardless of their title:
- Make decisions about the plan or the plan’s assets, such as disposition or investment options
- Give investment-related advice or recommendations directly or indirectly
- Exercise authority or responsibility in the administration of the plan
Plan administrators, administration committees for investments or retirement, boards of trustees, and plan trustees (such as a bank) generally are fiduciaries.
It’s important to know if you are at risk, and if so, what needs to be done to manage that risk. For instance, members of the board of directors or business owners are fiduciaries because they appoint the members of a 401(k) committee. Selecting committee members in a prudent, conflict-free way, and documenting the selection process, is key to fulfilling fiduciary responsibilities.
What are fiduciary responsibilities?
401(k) plan participants trust fiduciaries to make decisions on their behalf, such as choosing the investments available through the plan or selecting vendors. ERISA dictates what must be done in order to live up to participants’ trust, and design and operate plans in the best interest of participants. Expertise and objectivity are important to adhere to ERISA, as well as performing specific activities, including:
- Providing information so participants can make informed investment decisions. This includes transaction fees that may affect a participant’s account.
- Minimizing plan and investment costs
- Making decisions in the best interest of members of the plan and their beneficiaries
- Following the plan documents and updating the documents to incorporate any changes to the plan
- Paying only reasonable plan expenses from the plan to vendors
- Allowing participants to transfer funds at least quarterly. More volatile investments may require the option to transfer more frequently
- Selecting, reviewing, and replacing investments as warranted
- Monitoring employee and employer contributions
Several ERISA rules guide the responsibilities of a fiduciary:
- The Prudent Person Rule is that “a fiduciary shall exercise the judgment and care, under the circumstances then prevailing, which men of prudence, discretion, and intelligence exercise in the management of their own affairs, not in regard to speculation but in regard to the permanent disposition of their funds.” As with many of the other activities that fiduciaries perform, the details matter. Specific standards must be met to fulfill fiduciary responsibilities.
- Diversification Rule specifies that fiduciaries should provide alternative options to minimize the risk of large losses. A wide array of investment options allows participants to customize their portfolio based on their investor profile. Experts recommend at least three diversified alternatives with different risk and return characteristics.
- Exclusive Benefits Rule specifies that fiduciaries perform their duties solely to provide benefits to plan participants and their beneficiaries and operate with reasonable administration expenses. Fiduciaries cannot do anything that that is self-serving, even if it serves plan participants, and must avoid all conflicts of interest.
- Act in Accord with Plan Documents requires consistently acting based on a written investment philosophy, trust agreements, mission statement, and other key deliverables.
What are ways to reduce risk from 401(k) fiduciary responsibilities?
Complying with ERISA requires the right team, including an ERISA lawyer and experienced retirement plan advisor, which will work with you to consistently complete the types of activities listed below:
- Document all decisions pertaining to your 401(k) plan and actively archive plan meetings, reviews, and other materials
- Be prepared to provide operating expenses, prospectuses, a list of assets, and share valuations upon request
- Consider performance, risk-adjusted performance, fees, volatility, and manager tenure and turnover when evaluating investment funds
- Benchmark all plan providers frequently to assure that services and fees are reasonable
- Review your plan twice a year with your vendors and advisor
- Put your investment philosophy and mission statement in writing
- Simplify your plan as much as possible. Provide investment options that are easy to understand
- Know what fees you pay and what services are provided for the fee
- Know the share class options and qualifications for your investments
- Eliminate proprietary funds and revenue sharing
- Hire a Discretionary 3(38) Investment Manager, who assumes some of your fiduciary responsibilities
- Hire a completely transparent and fee-only Recordkeeper, TPA, and Custodian
- Do not “self-deal” or act on behalf of someone whose interests are adverse to the interests of the plan.
Sponsoring a 401(k) plan is complicated and those involved are potentially personally liable for plan losses. Some sponsors are unaware of all the risks and how to mitigate their exposure. This article introduced the standards and practices necessary to address 401(k) litigation risk to businesses and enhance plan outcomes—the law is extensive and plans require a team of experts to meet fiduciary responsibilities.
Eric Sholberg, CPA, AIFA serves as a retirement plan advisor at Brighton Jones.
This article is a high-level summary of the complexity and risks inherent to sponsoring a retirement plan—your ERISA lawyer and retirement plan advisor can provide an assessment and recommendation specific to your particular plan. The sole intent of this article is to raise awareness of the scope of risks, which varies with each plan and can be managed with the right team.