401(k) conflicts of interest misalign the interests of employers and 401(k) providers. While employers have a fiduciary responsibility to choose a 401(k) provider with “reasonable” administration fees and cost-efficient investments to make retirement as affordable as possible for plan participants, conflicted 401(k) providers have a financial incentive to push overpriced administration services and investments when lower-priced - but otherwise comparable - alternatives are available. How do conflicted 401(k) providers get away with it? Often by spinning a conflict as a benefit.
How do employers avoid this trap? With some basic education. Here are four ways a 401(k) provider can profit unduly at the expense of plan participants - not to mention, the employers sworn to protect their interests - in plain sight.
Limiting Funds to a “Preferred” List
ERISA imposes few investment-related 401(k) fiduciary responsibilities on employers. They boil down to picking – and maintaining - enough “prudent” investments to allow any plan participants to diversify their account “so as to minimize the risk of large losses.” ERISA does not define “prudent” but I think it’s safe to consider cost-efficient funds – basically funds that meet their investment objective for reasonable fees – to be prudent.
Some 401(k) providers make prudent fund selection harder than others by limiting an employer's investment options to a “preferred” list of funds. Because there are thousands of investment funds available to 401(k) plans today, this limitation can seem like a Godsend to employers, However, the funds on these lists are rarely the best – they’re simply the ones that will pay the 401(k) provider enough revenue sharing.
In short, a preferred fund list can make picking a prudent 401(k) investment menu impossible. Two better options for employers: 1) modeling their menu after the Federal Thrift Savings Plan or 2) hiring a fiduciary-grade financial advisor for impartial (conflict-free) investment advice.
Serving as the Named Fiduciary
All 401(k) plans have the same basic fiduciary hierarchy. The 401(k) fiduciary hierarchy includes both fiduciary and non-fiduciary (“ministerial”) roles. In general, the fiduciary roles have discretionary authority, while the ministerial roles do not.
The “named fiduciary” sits atop the 401(k) fiduciary hierarchy with the power to delegate all other roles. In most single-employer 401(k) plans, the employer is the named fiduciary. In a Multiple-Employer Plan (MEP) or Pooled Employer Plan (PEP), employers delegate the role to the provider.
Supporters claim this delegation reduces the fiduciary liability of business owners. I think it does the opposite by giving a 401(k) provider too much discretionary control over plan assets and features. They can abuse this power by delegating lesser roles to related companies (to layer fees), choosing plan features and investments that prioritize profit ahead of participant interests, or even misappropriating plan assets.
Limiting Plan Designs to Cookie-Cutter Options
401(k) plans are highly-customizable. They can be tailored to meet very different employer goals – including maximizing business owner contributions, incentivizing elective deferrals, or providing a minimum retirement benefit to low-wage workers. The process of matching an employer’s plan goals to available 401(k) options is called plan design.
Unfortunately, not all 401(k) providers offer consultative plan design. Instead, they limit an employer’s plan design options to a handful of cookie-cutter designs. This limitation can seem convenient, but it’s often meant to steer clients towards basic designs that are easy for the 401(k) provider to administer.
Don’t fall for it. Choosing the wrong plan design can cost an employer thousands of dollars in unnecessary contributions or hours of avoidable administration annually. A plan design expert can lead the process in 30 minutes or less. This time can make or break a plan’s success. Employers should settle for no less.
Discounting Other Corporate Services
Lots of companies offer 401(k) services in addition to other corporate services - including banks, insurance companies, and payroll firms. Often, these companies will discount their services when an employer “bundles” two or more of them. In my experience, payroll companies and banks bundle their 401(k) services most aggressively. For example, payroll companies will sometimes discount their payroll services when they’re also hired for 401(k) administration, while banks might offer lower interest rates on loans or raise rates on savings.
Regardless of how attractive these discounts might be, employers can’t let them influence their 401(k) provider choice because they have a fiduciary responsibility to act in the sole interest of plan participants. If an employer puts their interests first, they could be accused of “self-dealing”– one of the top reasons why 401(k) fiduciaries are sued today.
Overlook 401(k) Conflicts of Interest at Your Peril!
The 401(k) industry is rife with conflicts of interest. Not all 401(k) providers exploit a conflict, but employers must be able to identify and evaluate conflicts. Otherwise, they risk avoidable losses for plan participants and fiduciary liability for themselves.