When you decide to establish a retirement plan for your employees, you need to realize that you could be opening yourself up to additional risk.
By virtue of sponsoring a qualified retirement plan for your employees, such as a 401(k) plan, you are automatically considered a fiduciary. As a plan fiduciary, you must understand the standards of conduct, the regulatory agencies that govern qualified plans, and what is expected of fiduciaries.
Fiduciaries have important responsibilities and are subject to standards of conduct because they act on behalf of participants in a retirement plan and their beneficiaries. Plan sponsors that are automatically considered fiduciaries are expected to provide services according to five basic principles of fiduciary duty - prudence, loyalty, exclusive purpose, diversification, and adherence.
- The duty to act prudently is one of a fiduciary’s central responsibilities under the Employee Retirement Income Security Act ("ERISA"). Prudence focuses on the process for making fiduciary decisions.
- Fiduciaries are expected to act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them.
- Another key fiduciary responsibility is diversifying plan investments and paying only reasonable plan expenses.
- It is important that fiduciaries understand and follow the plan documents.
ERISA - Employee Retirement Income Security Act
ERISA is a federal law enacted in 1974 to regulate employer-sponsored retirement and welfare benefit plans. It is through ERISA that a federal standard of conduct is imposed with specific duties on plan fiduciaries. It is the responsibility of the Department of Labor ("DOL") to enforce ERISA. The DOL has many similar responsibilities to that of a plan fiduciary, including keeping a close eye on employers to ensure that plan participants’ best interests are adequately served.
As a plan fiduciary, you are expected to follow seven common fiduciary standards. These standards make up the foundation that guides a fiduciary as the traditional investment management process is carried out.
- Know standards, laws, and trust provisions.
- Diversify assets to the specific risk/return profile of the client.
- Prepare an investment policy statement.
- Use “prudent experts” (money managers) and document due diligence.
- Control and account for investment expenses.
- Monitor the activities of “prudent experts”.
- Avoid conflicts of interest and prohibited transactions.
These responsibilities may be more than you expected to take on when you started up your retirement plan. You might be asking yourself if there is any way to reduce or eliminate these fiduciary responsibilities. The short answer is no. There is no way to eliminate your fiduciary responsibility as a plan sponsor, but there is a way to share in the responsibility. Back in February of 2015, President Barack Obama called on the DOL to update the rules and requirements pertaining to retirement advisors. He recommended that advisors need to put the best interests of their clients above their own.
Certain retirement advisors, such as Registered Investment Advisors, can share in the fiduciary responsibilities with plan sponsors. Under ERISA Section 3(21), an advisor acts as a directed fiduciary. The advisor recommends appropriate investment options and investment models to the plan sponsor. In this case, the plan sponsor ultimately approves or rejects the recommendations. Under ERISA Section 3(38), an advisor acts as a discretionary fiduciary. The advisor is provided full discretion over the plan assets, selecting and implementing the investment options, and models on behalf of the plan sponsor. This allows the plan sponsor to share some of their fiduciary responsibilities with the retirement advisor.
Effective April 2017, the DOL has established the requirements called upon by President Obama to be put in to place. For advisors that share in the fiduciary requirements with their plan sponsors, not much will need to change. For retirement advisors that sell commission-based products, don’t act as a fiduciary, or don’t place the best interests of the plan participants first, they are going to have to make significant changes to their business model.
While you cannot entirely remove the risk from sponsoring a qualified retirement plan, you can prepare yourself for any questions that might arise from the DOL by knowing your fiduciary responsibilities and hiring an advisor that helps to share in those responsibilities.
All information herein has been prepared solely for informational purposes only and opinions are subject to change. Past performance is not indicative of future results and all investments involve the risk of loss of principle. For information on how these general principles apply to your situation, consult an investment professional.