Driven by an interest in attracting talented personnel and a natural
aversion to the financial risks attached to traditional defined benefit
pension plans, employers have embraced 401(k) plans, making them the
dominant retirement savings vehicle in the United States. In the past ten
years alone, participation has more than doubled.
As the 401(k) universe has expanded, the legal rules and regulations
governing plans have become increasingly complex, and countless unwary plan
fiduciaries have found themselves in serious trouble for unknowingly
breaching their legal duties.
This newsletter explains the basic rules for 401(k) plan fiduciaries in
order to make those that control the assets of or exercise discretion over
plans aware of the possible pitfalls.
ERISA Fiduciaries and Their Duties
The Employee Retirement Income Security Act of 1974 (ERISA) imposes
rigorous standards on plan fiduciaries, and a fiduciary that breaches any
obligation or duty can be held personally liable to make good any losses
incurred by the plan resulting from the breach. Because the stakes are so
high, it is important that all fiduciaries understand and comply with ERISA.
Who is a Fiduciary?
A fiduciary is anyone that controls the assets of a plan or uses
discretion in administering and managing the plan. When an employer
establishes an ERISA plan, it is the initial fiduciary.
The employer needs to decide whether to appoint individuals or committees
to be responsible for those duties. If a plan committee is appointed, then
the committee members are fiduciaries and must perform their duties under
ERISA’s "prudent expert" standard.
Further, the appointment of a fiduciary is itself a fiduciary act. So,
whoever appoints the officers or committee members has a duty to prudently
select those persons and to periodically review their work to make sure they
are doing their job. Typically, it is the board of directors or corporate
president who appoints the fiduciaries.
ERISA’s General Fiduciary Duties
The primary duty of all ERISA fiduciaries is to act solely in the
interest of plan participants and beneficiaries. Plan fiduciaries must:
- Carry out their duties with the care, skill, prudence and diligence of
a prudent person;
- Defray reasonable plan expenses; and
- Act in accordance with the plan documents.
Additionally, plan fiduciaries have an obligation to avoid engaging in or
causing the plan to engage in prohibited transactions.
ERISA prohibits fiduciaries from engaging in a variety of transactions
that are inherently tainted by conflicts of interest. Specifically, a
fiduciary may not engage in transactions with the plan in which he uses plan
assets for his own interest, acts for a party whose interests are adverse to
the plan or plan participants or receives compensation from a party dealing
with the plan.
Consequences of a Fiduciary Breach
Plan fiduciaries can be held liable for both their direct actions or for
the actions of co-fiduciaries. In addition to being held personally liable
for a fiduciary breach, the fiduciary must restore any profits made by the
fiduciary through the use of plan assets and is subject to any equitable or
remedial relief as the court may deem appropriate, including removal of the
The DOL will also assess a civil penalty against any fiduciary who
breaches the fiduciary duty requirements. Therefore, it is important that
all fiduciaries understand and comply with ERISA’s fiduciary provisions.
Common Fiduciary Issues
Fiduciaries need to understand the legal requirements for retirement
plans and monitor compliance with those requirements. Some of these
responsibilities include timely deposits of employee deferrals, enrolling
and covering the right employees, satisfying disclosure requirements and
selecting and monitoring investment options.
DOL regulations state that once a portion of the employee’s salary is
withheld, the money becomes a plan asset and, therefore, must be remitted to
the participant’s account as soon as is reasonably possible but no later
than the 15th business day of the month following the payday. Failure to do
so is a violation of one’s fiduciary duties and, if the funds are held
commingled with the employer’s funds, the fiduciary has engaged in a
Many plans operate under the misconception that because they contribute
the funds to the plan by the 15th of the month, they are acting in
compliance with ERISA. This is simply not the case. What is "reasonably
possible" will vary by plan, but it could be as short as a couple of days.
The same rule applies to the remittance of plan loan repayments.
Enrolling and Covering the Right Employees
Being a plan fiduciary is largely about paying meticulous attention to
detail. That is especially true in the difficult area of plan enrollment.
Fiduciaries have a duty to prudently implement the plan’s enrollment and
eligibility provisions. The plan must carefully monitor the workforce and
ensure that employees meeting the plan’s eligibility requirements are being
afforded the option to take advantage of the plan.
Part-Time Employees: Part-time employees are easily overlooked by plan fiduciaries due to the
misconception that all part-time employees can be excluded from
participation in the plan. However, the Internal Revenue Code does not
permit part-time employees to be excluded as a class.
A qualified plan may be drafted to require that an employee work a
minimum number of hours to enter the plan, but the maximum number of hours
that can be required in a twelve-month period is 1,000. This maximum
translates into approximately 20 hours a week, making many part-time
employees eligible for plan participation.
Controlled Groups and Affiliated Service Groups: If the plan sponsor is a member of a controlled group (businesses that
are considered to be under common control) or affiliated service group (two
or more service organizations that have a service or management
relationship), employees of other companies may be required to be included
in the plan.
Controlled groups and affiliated service groups are required to treat the
employees of all members of the group as if they were employed by a single
employer for nondiscrimination testing purposes. Depending on the test
results, it may be necessary to enroll employees from related companies.
It is important for fiduciaries to be aware of the controlled group and
affiliated service group rules and to notify the plan’s advisors if the plan
sponsor forms or acquires any other businesses in order to determine if
these employees are eligible for plan participation.
Keeping a careful eye on the employees’ eligibility is tricky, and a
wrongful denial will result in a fiduciary breach.
Reporting and Disclosure Requirements
401(k) plan fiduciaries have to make two types of disclosures to meet
their fiduciary duties: public disclosures made through government reporting
and disclosures made directly to participants.
One of the most cumbersome projects a plan fiduciary faces is the annual
filing of Form 5500 with the DOL. Form 5500 is a government mandated return
comprised of a main document and, in some cases, multiple schedules, that
reports information relating to the plan and its operation.
Because most DOL audits are initiated after investigators discover
abnormalities on the plan’s Form 5500, it is imperative that the 5500 is
prepared with the utmost skill and care.
Other disclosures must be made directly to plan participants. First and
foremost, the plan must automatically provide participants with a summary
plan description (SPD) which explains the benefits provided and how the plan
operates. The SPD is essentially an abbreviated version of the plan’s
governing documents written in a manner calculated to be understood by the
common plan participant.
After the SPD is distributed, plan fiduciaries must continue to make
participants aware of material changes to the plan through explanations
called summaries of material modifications (SMMs).
Also, a summary annual report, which is a brief summary of Form 5500,
must be provided annually to each participant or beneficiary.
Selection of Investment Options
401(k) plan fiduciaries are, in most cases, responsible for selecting a
plan’s investment options. In making these selections, there are a number of
factors that a fiduciary should take into account.
First, the fiduciary should regularly monitor the fees, costs and overall
performance of a plan’s investment options. Putting investment options on
"auto-pilot" without review for long periods of time can expose a fiduciary
to claims of liability if these investments change focus or go through a
long period of decline.
Second, because many 401(k) plans rely on the rule in section 404(c) of
ERISA that shields a fiduciary from liability where a participant directs
the investment of his account, it is important that the fiduciary comply
with section 404(c) regulations. In order to be afforded 404(c) protection,
over 20 requirements must be satisfied that fall into the following three
- Offering a broad range of investment alternatives;
- Permitting participants the ability to exercise control of their
- Providing participants with specific information disclosures to help
them make informed investment decisions.
Fiduciaries who comply with all of the provisions of the 404(c)
regulations are still liable for choosing and monitoring the plan’s
Third, because some participants have more background in investing than
others, it is always important to make sure that a plan’s investment options
and the descriptions of these options are understandable to the average plan
Fortunately, fiduciaries can act to limit potential exposure by relying
on competent outside advisors to assist with complicated matters. The plan
fiduciary’s obligations do not end with the selection of a service provider
because ERISA imposes an ongoing duty to monitor with reasonable diligence
the providers in order to ensure that they are meeting the plan’s
There is no doubt that employees will continue to want 401(k) accounts
and employers will continue to provide them. By understanding ERISA’s
fiduciary rules and strategically using competent service providers, the
prudent 401(k) plan fiduciary can both limit legal exposure and protect
participants’ retirement accounts.
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