3 Steps for Business Owners to Outsource 401(k) Fiduciary Liability
posted by Nathan Fisher August 8, 2018
When an employer chooses to offer a 401(k) on behalf of their employees, they take on more legal risk than they often realize. Managing a 401(k) plan brings with it a serious legal responsibility to make reasonable decisions, and I’ve found that some business owners and their 401(k) managers don’t fully understand their liability in this matter. Others do understand, but may believe their 401(k) service providers are taking on that risk—even if that’s not the case.
Here’s a how-to guide to not only help you pinpoint your 401(k) liability, but also to outsource your fiduciary risk to the right 401(k) partners.
Step One: Identify 401(k) liability so you can work to decrease it
Even if your 401(k) adviser has never spoken with you about liability before, it’s safe to say you do have liabilities that you need to explore. The best place to start is to become familiar with the Employee Retirement Income Security Act of 1974 (ERISA). ERISA provides guidelines for defined contribution plans like 401(k)s, and outlines the fiduciary responsibilities of any employer offering a plan. Simply put, this term “fiduciary” means employers have a legal responsibility to make reasonable choices on behalf of their employees in the plan, and this includes both the administration of the plan and also investment decisions.
Some 401(k) service providers can offer help sharing an employer’s fiduciary liabilities, but not all providers are the same, which leads some providers to gloss over the full extent of their abilities in order to make a sale. Take, for example, the owner of a manufacturing firm in the Midwest I recently spoke with. I was discussing my firm’s fiduciary services with him, and he said that he was already receiving this kind of service from his current 401(k) adviser. When I took a look at his contract, however, I found that it said specifically that his adviser was not acting as a fiduciary—but this was buried in the contract and wasn’t directly addressed in conversation. The adviser told the employer they were taking care of everything, though that wasn’t exactly true. In order to fully understand how much of your liability is being shared or covered by your current 401(k) service providers, ask for the fiduciary details in writing and double check you’re getting the coverage you need.
My advice to this business owner—and to anyone who thinks their 401(k) liability is being covered—was two-fold:
1. Review your service contracts: First, dig out any contracts you have with your 401(k) service providers and read the fine print. See what it says about fiduciary responsibility to uncover exactly how much support you are receiving in this area.
2. Seek out fiduciary education: Second, if your adviser is not educating you about fiduciary responsibility, find some education for yourself. I recommend attending an event from The Plan Sponsor University or finding resources that will walk you through your responsibilities and some best practices for managing liability.
Step Two: Get 401(k) fiduciary help
The next step is to get help from 401(k) service providers to manage 401(k) liability. This liability comes in two forms—administrative responsibility and investment management.
Outsourcing Administrative Liability
One major responsibility of an employer is to properly administer a 401(k). That includes tasks like preparing benefit statements, processing contributions and distributions from the plan, testing the plan for compliance, and preparing reports required by the Internal Revenue Service and the Department of Labor. ERISA section 3(16) allows employers to outsource this responsibility to third party administrators (TPA). The 3(16) administrator is responsible for managing the day-to-day operation of the plan, and in turn you as an employer are responsible for monitoring all of your service providers.
Outsourcing Investment Liability
The other primary source of employer liability as it relates to a 401(k) plan is investment management. Investments and the fees associated with them are the biggest cause of 401(k) lawsuits, which has led 83% of employers to re-assess their plan fees.1 Many employers receive some level of support from their service providers in choosing investments for the plan, but that does not necessarily mean that their providers are acting as fiduciaries, sharing in the employer’s legal responsibility to make sound investment decisions and ensure investment fees are reasonable. There are two types of investment liability services you can receive from a 401(k) adviser, each defined in ERISA:
• 3(21), which is more broadly available and more of a “co-fiduciary” service, in which an adviser offers investment recommendations that the employer is ultimately responsible to accept or reject
• 3(38), which is a more specialized skill that allows an adviser to make investment choices—like selecting funds or providing alternative investment options for the plan lineup—on behalf of the employer
Among advisers who are retirement plan specialists (meaning more than half of their business comes from retirement plans), only about half are able to offer 3(38) services, and only a quarter of those offer them as a standard part of their contract.2 My firm is able to offer both 3(21) and 3(38) services. I often recommend 3(38) to employers because the price increase is not large, and 3(38) means less risk for the business owner when it comes to choosing investments.
When reviewing the services you receive and considering your options for outsourcing 401(k) liability, look specifically for 3(16), 3(21), and 3(38) codes so you can understand the extent to which your service providers will share in your responsibility. Additionally, one way larger institutions tend to hedge their bets is by purchasing liability insurance for those individuals beyond the owner who have a hand in either administrative or investment management duties. It can be expensive, but it’s one institutional best practice that may be worth considering if you’re concerned about liability for other members of your staff who may play a role in managing your plan.
Step Three: Keep monitoring your plan and service partners to avoid conflicts of interest
Even when an employer secures a full line of liability-limiting services like 3(16) and 3(38) from their service providers, they will retain the responsibility to continually monitor their 401(k) plan. ERISA holds employers responsible for ensuring that reasonable decisions are being made for the benefit of employees in a 401(k), and in this case, that means keeping tabs on your chosen service providers. This involves three activities:
• Monitoring your providers: Monitoring your plan and your service providers will allow you to make sure that the plan is being administered correctly, that fees are kept reasonable for the services you’re receiving, and that you avoid conflicts of interest.
• Avoiding conflicts of interest: A conflict of interest could take a variety of forms: Maybe a service provider will offer you lower rates on your payroll service if you also use their 401(k) service, or a 401(k) adviser will recommend their name-brand investment options over others because they have a vested interest to do so. The easiest way to combat any potential conflicts of interest in your plan, especially when you’ve outsourced your investment decisions through a 3(21) or 3(38) service, is to request an ADV2 document from your 401(k) adviser. The ADV2 document is required by the Investment Advisers Act of 1940, and it identifies conflicts of interest in your plan. If they can’t provide this document, this could be a red flag that your adviser doesn’t hold themselves to the standards of the Investment Advisers Act, and they may not be the best choice for outsourcing your liability.
• Documenting your work: If your 401(k) adviser can provide an ADV2, you should regularly ask for new copies at least once a year so you can review it, highlight any potential conflicts of interest, record your findings in your fiduciary audit file, and address any issues with your adviser. I also recommend filing in your fiduciary audit file the contracts I recommended you review with your notes highlighting the specific fiduciary services you’re receiving. Also ask for, review, and file any other disclosures your adviser can provide, like the 408(b)(2) fee disclosure.
Decrease Your Risk
For business owners looking to limit their 401(k) liability, it’s important to seek out as much information as possible. Review your fiduciary responsibilities under ERISA and review your service contracts closely to understand exactly what liabilities you face as a business owner offering a 401(k) plan, or as someone managing a 401(k) plan for their company. Look for specific ERISA codes like 3(16), 3(21), and 3(38) for insight into the extent of the fiduciary services you receive, and document any decisions you (or your providers) make to monitor for conflicts of interest and other potential issues. The best way to manage liability is to face it head-on. Follow these steps I’ve outlined here, and you can do just that.
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