Financial Opinion and Insights

The 401(k) Landscape in Simple, Plain English

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

You’d be surprised how many business owners think their 401(k) plan is free.  It’s a ridiculous assumption, but many believe it.   It’s not their fault, though.  The landscape were designed to be confusing, they couldn’t have done a better job of it.

Retirement plans are regulated under the Employment Retirement Income Security Act (ERISA) with the purpose of protecting plan participants.  Once you realize that the plan participant, not the plan sponsor, is ERISA’s priority, you’re on your way to understanding fiduciary liability.

Now, I’m not an ERISA attorney, nor did I stay in a Holiday Inn Express last night – and plain English explanations require a little over-simplification, so I’ll take a shot at it.  But, be sure to discuss this with your attorney.   Okay, here’s the oversimplified, plain English inside look:

Who’s a Fiduciary?

If you sponsor a plan, you’re a fiduciary under ERISA.  If you make decisions concerning the plan, you’re a fiduciary, regardless of your title – you can be the company janitor and still be a plan fiduciary.  If you give plan advice, you can be considered a fiduciary – even if you’re a receptionist.  The fiduciary’s primary responsibility is to the plan, i.e., plan participants.

Why it’s important:  Fiduciaries can be held personally liable for their decisions.  Yes, personally.  No corporate veil protections.  ERISA won’t allow plan fiduciaries to hide behind the company when participant money is involved.   Problems generally arise when a fiduciary is held to have breached their fiduciary obligations with regard to the plan.  Most often, this happens due because of a failure to follow and document a prudent process in carrying out their duties or when a `prohibited transaction’ occurs – something that’s a little too complicated to go into here; but, it is a issue worth discussing with your ERISA attorney.  Note:  You need an ERISA attorney.  The one you use for your estate plan isn’t the one you need.

The Players

  • Plan Sponsors:  Individuals or companies that sponsor 401(k) plan(s) for their employees.
  • Plan Fiduciaries:  Those who make decisions regarding the plan.
  • Plan Participants:  The employees who each have their own retirement accounts inside the plan.
  • The Record Keeper:  Generally the plan provider.  The record keeper makes sure plan assets are recorded to participant accounts and provides reporting services.  These are not fiduciary functions; they’re administrative.  Plan providers are vendors.
  • The Administrator:  A TPA (third party administrator) Handles administrative duties, i.e., discrimination testing, IRS filings, fee payments, plan amendments, etc.  None of these are fiduciary functions; they’re administrative.
  • The Plan Financial Advisor:  Traditionally, this has been the plan salesperson who sells the `bundled’ solution to the employer for a commission.  This role is changing drastically as more plans are using fee-only Registered Investment Advisors to provide plan consulting services instead of commission-based brokers, for reasons you’ll soon see.
  • The Plan Investment Manager:  The investment fiduciary – the one who makes the investment decisions.  The one who has the final say on the investment line-up (which funds and options you include) is the investment manager; and this IS a fiduciary function.  You may think you’re not the manager; but you’d better consult your vendor agreement – chances are YOU are the investment fiduciary.

The `Shell Game’

Since plan sponsors are becoming more aware of their potential liabilities, plan providers have come up with a marketing gimmick.  They call themselves `co-fiduciaries’ in their marketing material, but expressly avoid any such liability by limiting their `advice’ to line-up `recommendations’  and participant education, i.e., they do not provide actual investment advice to participants.   The marketing leads sponsors to believe the provider is `taking care of everything’, but they’re sadly mistaken.   Remember, the provider is still only a vendor.  The choice of provider is a fiduciary act.  The fiduciary must act in the best interest of the plan, i.e., the participants.

Most vendors like selling a ‘bundled’ solution.  The reason is simple:  It’s easier to sell and they can make the plan look `free’ to an unsuspecting plan sponsor.

Note:  Our government is designed with three branches:  Executive, judicial, and legislative.  The purpose of the design is to provide a `checks and balances’ so that no one branch can control government.  Indeed, this hasn’t always worked, particularly when one party controlled all three branches.

A good plan has three components:  Recordkeeping, administration, and investment management.  When these three functions are handled under a ‘one-stop shop’, it’s often a recipe for abuse, with the plan sponsor left on the hook as the fiduciary holding the bag.

Example:  ABC Wigits wants a `free’ plan.  The company president is told by a vendor they can handle everything!  They are a third-party administrator who can handle design, record keeping, and everything else, top to bottom.  What’s more, it’ll be dirt cheap!

It’s all done with revenue-sharing – something I liken to `kickbacks’ – TPAs hate it when I use that term.  But, you tell me what it is when money is steered to specific mutual funds who, in turn, pay revenue sharing to the TPA?   And, some mutual funds companies pay higher revenue sharing than others – so, guess which ones get chosen for the fund line-up?

Would YOU call that a fiduciary best practice on behalf of your participants?   Choosing revenue sharing funds is a common practice, with the `kickbacks’ used to defray the fees TPA’s charge to the account balances of plan participants.

Do you doubt the plan’s commissioned sales person is selecting funds that pay the most revenue sharing?  After all, if s/he’s commissioned on the revenue generated for the TPA firm, that could represent a conflict of interest.  No wonder, they don’t really want fiduciary status for investment selection.

There’s nothing illegal about any of this.  Indeed, responsible TPAs are now getting out front by disclosing all revenue sharing used to offset fees and are not trying to line their pockets.  But, that doesn’t get plan sponsors ‘off the hook’.  After all, they are the ones charged with having a documented process for the selection of all service providers, including the investment line-up.  And, eliminating conflicts of interest is an obvious place to begin.

Staying Out of Trouble

Here are five simple tips – again, in oversimplified plain English. 

  1. Avoid questionable revenue sharing arrangements that could influence fund selection.  Do not use your TPAs in-house investment advisory firm.  Keep a Chinese Wall between all players.  TPA-administered plans with no financial advisors are even worse because these payroll providers will offer mutual fund lineups while clearly stating they are not offering advice or acting in any fiduciary capacity.
  2. Use an independent plan advisor to develop an investment policy statement (IPS) with plan trustees, conduct vendor searches, provide education at both the plan level (fiduciary) as well as the participant level, where the need is for real help, i.e., advice beyond education.  While a ERISA 3(21) fiduciary advisor can advise on fund selection, asset allocation, and investment line-up, they can help plan sponsors who want to truly minimize their liability by helping the sponsor conduct an independent search for an ERISA 3(38) investment manager – which truly transfers the responsibility, and liability, for investment selection to the manager.  While liability is greatly reduced, it’s important to remember, the selection of a 3(38) advisor is still a fiduciary act, and you need a prudent process for selection, as well as the in-house education and participant advice component.  Your independent 3(21) plan advisor will also be providing monitoring and oversight of your 3(38) managers and, of course, the independent advisor works for the client, not the TPA or record keeper.  Your advisor is your guide to an independent, documented, prudent process for the fiduciary issues ERISA addresses.Remember, an investment advisor who is not independent and works for the TPA will always have a dual loyalty.  A loyalty to the client, sure; but, also a loyalty to provide a mutual fund line-up that will produce the most kickbacks – sorry, revenue sharing fees – to the TPA firm.  An independent advisor is paid from the plan on a fully-disclosed basis and has no incentive to provide revenue sharing for the TPA – indeed, the advisor works solely for the plan and in the best interest of plan participants – and that’s what ERISA is all about.
  3. Use an independent ERISA attorney.  The TPA’s attorney, like the sales rep, works for the TPA, not the plan sponsor.  Only an independent ERISA attorney will always act as an advocate for the client.  Remember, the in-house attorney doesn’t have an attorney-client relationship with you.  If a problem arises, guess which side the attorney will take!
  4. Avoid using a ‘one-stop shop’.  Checks and balances are one and the plan sponsor is virtually ALWAYS left as the true lone fiduciary at the mercy of the other players.  Besides, suppose you’d like to terminate one service provider, i.e., after terminating the TPAs legal department and/or investment services, how do you maintain a working relationship with their administration arm when bringing in others to handle those services independently?
  5. Don’t use your payroll company to run your 401(k) plan.  The two largest payroll providers in the country see 401(k)s as a natural ‘add-on’ profit center; but payroll services are an automated, computerized function, and too often they seem to run their 401(k) plans the same way.  While they talk about ‘seamless’ integration, I’m not so sure it’s all that seamless.  Plan administration has little to do with payroll.  The tasks of plan administration, record keeping, investment management, and plan advisory services are simply too many balls to keep in the air.  More importantly, the `checks and balances’ plan sponsors need is missing.  Further, they seldom if ever offer any real investment advice – nor do they offer a co-fiduciary role.  My favorite story is about the TPA/payroll provider `advisor’ who suggested a client add a small cap fund to the lineup and then insisted it wasn’t financial advice, just a suggestion.

This is rather short and admittedly over simplified.  Talk to an independent ERISA attorney and an independent plan consultant.  They’ll help you through the process of helping you put together your own independent financial group of service providers, each working for you, with loyalty only to your plan. 

Beginning next year, this issue will likely show up on the evening news!  The reason? New laws kick-in requiring plan providers to fully disclose all fees on participant statements, which means participants will likely start knocking on the doors of plan sponsors asking some questions.  Plan sponsors, and participants, who thought their plans were `free’ will likely be in for a shock – and without a documented process, answering questions may prove difficult, especially when the questions come from disgruntled former employees.

Remember, the buck stops with the one who makes the final decision.  And, delegation of authority IS a decision.



Jim Lorenzen is a Certified Financial Planner™ and An Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.