Employers: The Hidden Risks in Your 401(k) Plan

401(k) plans are a hot button issue right now. They’ve been in the news a lot lately for both positive developments, like new laws that promote pricing transparency, as well as negative events, like lawsuits brought about by employees for excessive fees, unfair practices or other violations of ERISA, the law that governs 401(k) plans.

Generally, responsibility for a company 401(k) plan falls on the business owner, HR manager, accountant or some other employee who has umpteen other tasks they’d rather be doing. Rarely is this person an expert in 401(k) plan design, implementation or review… nor should we expect them to be. They are, however, in most cases fiduciaries to the plan.

A fiduciary is someone who is ultimately responsible for the plan and must act in the best interests of plan participants, i.e. the employees that contribute to the plan. Being a fiduciary, in legal terms, requires an extremely high standard of care, with which come extremely high obligations. For example, a plan fiduciary can be held personally liable for certain problems relating to the plan, regardless of whether or not they knew of such issues. In other words, ignorance of the rules is not a valid defense. Most plan fiduciaries are not aware of the level of risk they are exposed to by virtue of their involvement.

There is good news, however. Some of the responsibilities of a fiduciary can be outsourced in the event the plan sponsor and other plan fiduciaries feel they need assistance or would rather not have the full weight of the risk on their shoulders. These same plan sponsors should proceed with extreme caution as not all plan providers take on the risks of being a fiduciary. Some claim they do but the contract language places one limitation after the other on their liability. Others suggest they are fiduciaries but refuse to make the same claim in writing. Any third party that is hired for purposes of fulfilling fiduciary duties must expressly take on such responsibility, in writing.

While hiring someone may alleviate some of the risks employers face, they can never eliminate all their fiduciary duty. In the best case scenario they are still responsible for evaluating the hired fiduciary, both at inception of the relationship and on a regular basis moving forward. This evaluation needs to be documented to remain in compliance with ERISA. It should be done independently and typically multiple bids should be solicited for both cost and service comparisons. Costs need not be the cheapest available but should be reasonable given the services provided.

It is in the evaluation of hired fiduciaries that many plan sponsors are likely to get into trouble, especially with the 401(k) industry already starting a consolidation, one that is expected to continue. One large, recent example is of The Hartford exiting the 401(k) business and their clients being acquired by MassMutual. Incidentally, neither The Hartford, nor MassMutual ever served in a fiduciary capacity to 401(k) plans unless they were partnered with a Registered Investment Adviser (RIA) that expressly took on such risks. This consolidation often is viewed indifferently by plan sponsors. In some cases an acquisition could be a positive thing, in others negative. In either case the plan sponsor (AKA fiduciary) has a duty to review the new provider as if they were hiring them anew. Such situations are perfect opportunities to put the plan out for bid to determine the best service providers available. Failure to do so can be a red flag to ever more vigilant regulators. Plan sponsors should be aware that with a merger or acquisition people and processes change (ask anyone who has been through one) and promises of business as usual should be verified, independently.

My advice to plan sponsors is simple, be aware of your options, service providers and costs.  Understand who is and isn’t a fiduciary to the plan and who is at risk. If you are personally at risk find out what steps can be taken to limit that exposure. 401(k) lawsuits are becoming more and more prevalent, and it’s not just the big plans that should be concerned. View any changes in personnel, service providers or changes to contracts or contract language skeptically and engage appropriate parties to review these changes as necessary.

We understand that many administrators view 401(k) plans as a necessary evil. Something that they need to provide to remain competitive for top talent, as such they are not deserving of your precious time. But an investment in setting up a great plan will not only attract better talent, and help company employees save more for retirement, but can also be a cost savings while simultaneously reducing risk for the company and the administrators.

About the author: Michael Prus is the President and Founder of Scale Investment Group, LLC, a registered investment advisory firm with offices in White Lake and Grand Blanc, Michigan. Scale Investment Group is a leader in providing low-cost institutional investment services, like 401(k) and 403(b) plans, to small and mid-sized organizations and also manages money for private clients. The firm is a champion for small investors promoting low-costs and transparency of the investment advisory industry. For more information visit scaleinv.com or contact Michael directly at mprus@scaleinv.com.