My favorite guiding principle is Occam’s razor, which Dictionary.com defines as “the maxim that assumptions introduced to explain a thing must not be multiplied beyond necessity.” I don’t know many 401(k) professionals that value Occam’s razor as much as I do. In fact, I think many actually favor overwrought and overly expensive solutions to 401(k) issues. I guess this probably makes a lot of sense from a business standpoint. After all, it’s easier to justify a higher fee for a complicated 401k solution than a simple one.
I see overwrought solutions for 401(k) fiduciary issues most regularly. They are not necessary. While 401(k) sponsors are subject to complex fiduciary responsibilities under ERISA, a qualified (and inclined) service provider can make it simple for sponsors to meet their fiduciary responsibilities with some basic “best practice” guidance. I will highlight some of my favorite guidance here.
The 4 key sources of fiduciary liability today
When meeting their fiduciary responsibilities, 401(k) sponsors should be mindful of the 4 key sources of fiduciary liability today:
- Paying excessive plan fees
- Selecting imprudent investments
- Not remitting participant contributions timely
- Failing to follow plan document terms
1. Paying excessive fees
Without question, the #1 source of 401k 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.
401k fiduciaries shouldn’t expect a lot of objective help from their plan service providers in judging the reasonableness of their fees, but fee evaluations do not need to be difficult. They can be done using a 3 step process:
- Collect the “408(b)(2)” disclosure for each plan service provider
- Review each disclosure for completeness
- Benchmark the service provider’s fees for reasonableness
I discuss these steps in greater depth in New Year’s Resolution # 1 for Fiduciaries – “I WILL Evaluate My 401k Plan Fees."
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) sponsors to “prudently” select investments. A prudent investment is one that meets plan investment objectives without charging excessive fees.
Unfortunately, many service providers don’t make it easy for 401(k) sponsors to meet this fiduciary responsibility. They can offer conflicted advice that results in excessive fees and reduced investment returns. When this advice is followed, fiduciary liability can result.
My suggestion for 401(k) sponsors – Do 2 things 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 a different fees. Fiduciaries should always choose the share class with the lowest expense.
3. Not remitting participant contributions timely
401(k) sponsors must deposit participant contributions (pre-tax/Roth 401(k) deferrals, loan payments) to the 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. For larger plans (100 participants or more), the determination of whether the deposit was timely is based on facts and circumstances.
Under their Employee Contributions Initiative, the DOL actively enforces these deposit standards. 401k sponsors can be subject to civil penalties if they are not met. Given this potential liability, 401k sponsors should prioritize deposits.
4. 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.
401k sponsors must be sure they understand the terms of their written plan document and operate their plan in compliance with it daily.
401(k) sponsors need not fear their fiduciary status
While 401(k) sponsors are subject to complex fiduciary responsibilities under ERISA, meeting these responsibilities does not need to be difficult. The key to reducing fiduciary liability is responsibility transparency and guidance from a qualified service provider.