The Prudent 401(k) Fiduciary
April 2007 Benefit Insights® Newsletter
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
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
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 fiduciary.
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
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 prohibited transaction.
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
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
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 categories:
- Offering a broad range of investment alternatives;
- Permitting participants the ability to exercise control of their investments; and
- Providing participants with specific information disclosures to help them make informed investment
Fiduciaries who comply with all of the provisions of the 404(c) regulations are still liable for choosing and
monitoring the plan’s investment options.
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 participant.
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 expectations.
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.
This newsletter is intended to provide general information on matters of interest in the area of qualified
retirement plans and is distributed with the understanding that the publisher and distributor are not rendering
legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter
without first seeking the advice of an independent tax advisor such as an attorney or CPA.
© 2007 Benefit Insights, Inc. All rights reserved.