How to Avoid Liability for 401(k) Plans

How to Avoid Liability for 401(k) Plans

A good question for employers to ask is “What do I need to do to avoid fiduciary liability for my 401(k) plan?”

There is a lot that can be done to manage that risk … too much for one article, more like a book. But, here’s my top tip.

Most 401(k) lawsuits against employers are about expenses . . . the cost of plan’s investments and its recordkeeper. (A “recordkeeper” is the primary service provider for 401(k) and 403(b) plans. In most cases, the recordkeeper maintains the website for the plan, executes the employee-directed transactions, and provides the daily and quarterly accountings of the employees’ investments. And, that’s just a partial list of their services.)

The claims in those lawsuits are that employers pay too much for the investments and services. If true, that reduces the value of the employees’ accounts.

While the employer is the primary fiduciary for a plan, most companies appoint committees to make decisions about their plans. As a result, the committee members are fiduciaries. For ease of reading, this article uses “committee” to refer to the fiduciary decision-makers.

How can committees know if the expenses are reasonable?

There are a number of ways to get information about expenses. One is to take the plan out to bid for new recordkeeping services and investments. Another is to ask the plan’s adviser for information about investment and recordkeeper expenses. Perhaps the best way, though, is to use “benchmarking.” To benchmark a plan, the committee members need information about the costs of other 401(k) and 403(b) plans, and then needs to compare the costs in your plan against other plans. Not just any benchmark will do, though. It has to be based on data for similar plans. For example, the cost of recordkeeping services should be compared to plans with a similar number of participants and a similar amount of investments. For investment expenses, the total value of the plan’s investments is the most important criteria.

A sophisticated benchmarking service will also tell the committee members the total compensation of the plan’s recordkeeper. While, at first blush, the compensation of a recordkeeper may seem obvious, that’s not the case. Recordkeepers often receive indirect payments and credits from the investments. (Those payments and credits are called “indirect compensation.”) Under the Department of Labor rules, indirect payments and credits are considered part of the recordkeeper’s compensation. If a recordkeeper’s compensation is too high, the committee needs to claim the excess compensation for the benefit of the plan and the employees.

What should the employer do with the benchmarking report?

The first part of the answer is obvious; the benchmarking reports should be read and understood. Since most committee members aren’t knowledgeable about expense ratios, recordkeeping fees, indirect compensation, and the like, the committee should have a meeting with the plan’s adviser to go over the reports. An adviser who regularly works with retirement plans will be able to explain the reports and help the committee make informed decisions.

An obvious red flag is if the benchmarking report shows that expenses are on the high side. For example, it would be difficult to justify expenses that are much more expensive than the costs incurred by similar plans. But, that doesn’t mean that above average costs are necessarily wrong. Instead, a committee needs to review the report and make sure that the plan’s costs, for both investments and services, are within a “range of reasonableness.” Generally speaking, the marketplace decides what’s reasonable. That’s why benchmarking is helpful.

The “range of reasonableness” is the range of the most common charges for comparable services or investments. Think in terms of a scatter gram, where the concentrated dots would be the range of reasonableness and an isolated dot (on the expensive end of the scale) could be unreasonable.

If committee members see that the expenses are on the high side, and beyond the range commonly charged, they have identified an issue that needs to be addressed. The question is whether the expenses can be justified by the quantity or quality of services received by the plan, as compared to the typical charges and services for similar plans. If the committee can’t justify the differences, the plan should negotiate for less expensive investments or lower costs for recordkeeping.

What can employees do about this? Unfortunately, employees don’t receive information about the recordkeeping costs for their plans. And, while the employees regularly receive information about the expense ratios of the investments in their plans, they don’t get information about costs of investments that are available for other similar plans. As a result, it’s hard for employees to evaluate the reasonableness of plan expenses. One source of information for some plans, particularly larger plans, is Brightscope (www.brightscope.com/ratings/). That’s a good place to start looking.

Fortunately, most employers do a good job of selecting reasonably priced investments and services. However, not all do … and that’s why employers and committee members get sued.

Source: Forbes
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