According to the Department of Labor’s (DOL) fiduciary guidelines– any individual or entity with discretionary authority over a 401(k) plan’s administration or investments is considered a “fiduciary” to that plan. 401(k) plan fiduciaries ordinarily include the employers, trustees, and investment advisors.
Over the past decade, several high-profile 401(k) lawsuits have put the topic of 401(k) fiduciary responsibilities in the national spotlight. While the consequences of failing to meet 401(k) fiduciary responsibilities can be severe, its easy to avoid.
Below are five key sources of 401(k) fiduciary liability:
1. Paying excessive fees
Without question, the #1 source of 401(k) fiduciary liability is paying excessive plan fees. This makes sense given the corrosive effect of fees on participant account balances. Fiduciaries must ensure the services provided to their plan are necessary and that contracts or arrangements for services, and the cost of those services, are reasonable. You shouldn’t expect a lot of objective help from your 401(k) provider in judging the reasonableness of their fees, but fee evaluations do not need to be difficult. We can help.
2. Selecting imprudent investments
Today, most excessive 401(k) fee lawsuits relate to hidden fees buried in plan investments. Hidden fees can make it difficult for 401(k) fiduciaries to “prudently” select investments. A prudent investment is one that meets plan investment objectives without charging excessive fees. Unfortunately, many 401(k) providers don’t make it easy for you to meet this responsibility. They can offer conflicted advice that results in excessive fees and reduced investment returns. When this advice is followed, fiduciary liability can result.
Fiduciaries should do the following when selecting plan investments:
◊ Use index funds as investment performance benchmarks – Given the universal availability of “passively-managed” index funds, all 401(k) participants should always earn no less than market returns on their account over time. While it’s OK for 401(k) fiduciaries to pay more for “actively-managed” funds or insurance products designed to beat an index, the performance of these investments should outweigh any additional expense◊ Choose the lowest expense share class – Mutual funds are often offered in multiple share classes, each with different fees. Fiduciaries should always choose the share class with the lowest expense
3. Not remitting participant contributions timely
You must deposit participant contributions (pre-tax/Roth 401(k) deferrals, loan payments) to your plan’s trust account on the earliest date they can reasonably be segregated from general corporate assets. For plans with fewer than 100 participants, a deposit is considered timely if it’s made within 7 business days after the date the contributions would have been otherwise payable in cash.
4. Not meeting reporting and disclosure requirements
401(k) plans are subject to various government reporting and participant disclosure requirements under ERISA. When required government reports (e.g., Form 5500) are not filed timely, civil penalties can result. When required disclosures (e.g., safe harbor notices) are not distributed to participants timely, civil penalties, plan disqualification by the IRS, or lawsuits from participants harmed by the lack of disclosure can result.
5. Failing to follow plan document terms
Under IRS rules, a 401(k) plan must operate in accordance with the terms of its written document to maintain its tax-favored status and prevent a breach of fiduciary duty. When a plan fails to operate according to its written terms, the IRS considers the issue an “operational defect.” A 401(k) plan can be disqualified for not fixing an operational defect. The IRS offers tips for avoiding, finding and fixing common operational defects on its website.
401(k) fiduciaries must be sure they understand the terms of their written plan document and operate their plan in compliance with it daily. While employers are subject to complex fiduciary responsibilities under ERISA, meeting these responsibilities doesn’t need to be difficult. The key to reducing fiduciary liability is responsibility transparency and guidance from a qualified service provider.