Summary Of This Document

 

Purpose

The purpose of this page is to explain employers’ and self-employed person’s options in 401(k) plan providers and to equip human resources professionals with an understanding of the 401(k) landscape so they can make better decisions for their company and for their employees.

 

Choosing the Right 401(k) Provider

If you are considering a 401(k) plan for your company, wanting to start a solo-401(k), or are responsible for managing the 401(k) for your company; choosing the wrong plan provider can be dangerous both to your company and to your employees. 401(k) plans are one of the most important benefits for attracting the best employees and providing employees with financial stability throughout their life. But choosing the wrong plan provider can significantly diminish employees’ retirement savings and open the company to legal liability.

The Danger of a poor 401(k) Plan

The stock brokerage, insurance, and mutual fund industries have done a wonderful job in helping companies provide a retirement for their employees. Unfortunately, many of these same companies set up 401(k) plans as massive cash cows that can deliver significant profits to the providers. High administration fees, poor investment options, high-cost funds, self-dealing practices, and commissioned sales are surprisingly common in many 401(k) plans.

Danger to Employers: legal liability

Employers who choose plan providers with conflicts of interest may be getting sold a plan that leaves them open to liability from employees. Many of the major plan providers have argued in court they are not responsible for the advice they give because their ‘advisers’ are simply sales representatives and do not legally give advice.

Lawsuits related to retirement plans are on the rise, with employers being sued for poor investment choices, high fees, lack of a documented review processes, and mistakes with plan filings and disclosures. Even major 401(k) plan providers are being sued by their own employees for issues with their retirement plans.

Danger to Employees: An Unfunded Retirement

The wrong 401(k) provider can leave employees with significantly fewer assets and less income in retirement, subjecting them to financial hardship and stress during their ‘golden’ years.

Choosing the right plan is extremely important as the vast majority of employees will rely predominantly or solely on their employer 401(k) plans to supplement Social Security in retirement. According to the Department of Labor, more than 2/3 of people with retirement plans are counting on 401(k)-style defined contribution plans for their retirement compared to traditional pension plans.

About the Author

Joshua Escalante Troesh is a Tenured Professor of Business and a Registered Investment Adviser who specializes in financial planning for small business owners and providing 401(k) plans to businesses. He has been quoted in Forbes, US News & World Report, Investopedia, The Street, and many other media.

Table of Contents

  1. Understanding the 3 Main Functions of 401(k) Providers

    • Questions to ask the adviser

    • Questions to ask the record keeper/administrator

    • Questions to ask the custodian

  2. Reducing Your Liability through Fiduciary Delegation

  3. Protecting Your Plan & employees - The Fiduciary Standard

  4. Getting Additional Help & About the Author

The 3 Main Functions 401(k) Providers Fulfill

Providing a 401(k) plan has three main components: The Adviser, The Record Keeper/Administrator, and The Custodian. While it is common for the large household-name providers to handle all three functions, it may not be in your company's or the employees’ best interest to have one company handling all three.

Despite what might be assumed, plans where three separate companies handle each of these functions often have lower overall fees. When all three functions are handled by the same company there is an incentive to compensate advisers based on the overall profitability of the plan, including from ‘hidden’ revenue sources.

When the functions are handled by three separate companies, each company can hold each other accountable for keeping fees down and protecting the client, assuming there are no back-end revenue-sharing agreements between the companies. As an example, with the 401(k) plans I provide, my pay is solely from the employer or the employees within the plan, so there is an incentive for me to switch custodians or administrators if their fees get too high or if I see concerns with how they do business.

The Adviser

The Adviser is the person your company will directly interact with. An adviser might be set up as a Registered Investment Adviser, a stock broker, an insurance agent, or a combination of the three. The adviser will recommend the investments you should have in your plan, and this recommendation can be offered as true advice or simply as a sales pitch. You can check out an adviser at BrokerCheck.org to verify their answers to the questions below and review their disciplinary record, if they have any.

Key Questions to Ask the Adviser

Are you a Registered Investment Adviser, a broker, and/or an insurance agent?
Currently, only Registered Investment Advisers are held to the Fiduciary Standard of being legally required to do what is in your company’s and your employees’ best interests. Brokers and insurance agents are salespeople of the company they represent and have a legal duty to do what is in their employer’s best interest, not their client’s best interest. While most advisers will say they will do what is in your best interest, unless they are a Registered Investment Adviser, you have no legal recourse if they don’t. You can read more about the Fiduciary Standard in the third section below.

What are your licenses?
There are a lot of licenses an adviser might have. Registered Investment Advisers hold the Series 65 license. If an adviser only holds this license, then they are compensated by the client for the advice they give. All other licenses in the financial services industry are commissioned sales licenses and allow an adviser to earn commissions for the financial products they sell (often disguised as advice).

Do you take on the legal liability for the investment plan as a 3(38) fiduciary?
Advisers who are fiduciaries can take on some or most of the fiduciary liability for the investments offered in the plan. You can read more about this below, but the upside is an adviser who takes on the fiduciary liability significantly reduces the liability to your company.

Who do you use as the record keeper/administrator and custodian of the plan?
You will want to make sure the record keeper/administrator and the custodian are major companies with significant experience in their respective fields. This is especially true for the custodian as this company will actually hold your plan’s money. The custodian should be a large, well-recognized financial institution with a long history of protecting investors’ funds. If you’ve never heard of the custodian, it is a red flag. My firm uses TD Ameritrade or Charles Schwab as the custodian which holds plan money; while Bernie Madoff used Westport National Bank, a Connecticut bank with one office and just nine affiliated branches.

How do you choose investments that go in the plan?
This is definitely the question with the most subjective ‘right’ answer. Investment strategies vary significantly by adviser, and there is no single correct strategy. You want to see they have a structured process for choosing investments, emphasize low-fee fund options, avoid using mostly or solely one company’s funds, and have a strategy that incorporates a plan for minimizing your company’s liability for offering limited investment choices. And regarding minimizing liability for limited investment choices; just having a lot of fund choices does not, by itself, meet ERISA legal requirements.

The Record keeper/Administrator

The Record Keeper and Administrator of your plan will be responsible for documenting transactions, filing government reporting forms, keeping records, and providing legally-required disclosures and other information to employees and plan participants at the appropriate time. Most are not household names, but you will want to look for a company that is low-cost and has significant experience doing specifically this function. Along with extraordinarily high fees and outright fraud, the administrator/record keeper presents the biggest liability risk for your company if legally-required disclosures and timelines are not met.

Key Questions to Ask about the Record Keeper/ADMINISTRATOR

Do you have ERISA and Tax attorneys on staff?
This function of a 401(k) plan is heavily steeped in both tax law and the Employee Retirement Income Security Act (ERISA). Having attorneys who specialize in these two areas of the law, and any changes that occur due to court cases, is extremely important to the record keeper/administrator being effective in providing the proper guidance and service to your plan.

How do you ensure disclosure and timeline requirements are met?
It would be extremely scary if the record keeper/administrator did not have a detailed and controlled process for ensuring everything the law requires is accomplished in a timely manner. While you will likely get the same, good answer from every provider, it is still wise to ask.

How is the record keeper/administer fee calculated?
Most record keepers/administrators charge a fee as a percentage of assets. While this is advantageous when the plan has few assets within it, the fee can quickly become astronomical as the plan grows. The fee should at the very least offer breakpoints with a reduction in the percentage as the plan assets increase. Or even better, look for a fee mostly made up of a flat-fee and a small dollar amount per employee. These fees will increase much more slowly and will become relatively cheaper as the retirement plan grows in size.

What is your process for watching over the actions of the adviser and the custodian?
One of the major advantages of having three companies do the three main functions of a 401(k) plan is they help hold each other accountable. The record keeper/administrator is in the unique position to monitor what is going on at the advisor and the custodian levels. While it is not their responsibility to catch all fraud (your company is always responsible for doing your own monitoring) a good record keeper/administrator can be an important ally in helping you protect your plan’s assets and reduce your company’s liability.

Will you take on the fiduciary liability for plan administration as a 3(16) fiduciary?
Your company can further reduce it’s liability by delegating the fiduciary administrative functions to an administrator who takes on paperwork, disclosure, and filing responsibilities as a 3(16) fiduciary. Again, you can read more about this below, but the upside is the administrator taking on this role significantly reduces the liability to your company.

The Custodian

The Custodian of your plan will be the company which actually holds plan assets and accepts the plan money. This will be the company who receives the money from your company for the plan and will distribute the money back to plan participants. Here, bigger is truly better, and you will want one of the large, well respected, custodian financial institutions as the company that holds the money. Examples of custodians with long histories of protecting investor assets (in alphabetical order) include Charles Schwab, Fidelity, TD Ameritrade, Vanguard, While there are many other good custodians beyond this limited list, you want to make sure the custodian isn’t an unknown company.

Key Questions to Ask about the Custodian

Do they have SIPC and additional insurance for plan moneys?
The SIPC is the government insurance program that protects investor money from losses due to fraud, similar to how the FDIC protects depositors money with banks. Unlike the FDIC, however, investors can always lose money in their investments and the SIPC insurance will not cover the losses. SIPC and additional insurance only covers instances of fraud or other criminal activities, not investment losses. Many custodians will purchase additional private insurance to increase the protection for investors to amounts much higher than the SIPC covers.

How can plan participants access their accounts and information related to their accounts?
Custodians should send statements directly to plan participants on at least a quarterly basis. While advisers and record keeper/administrators may also send statements, the employee should always have direct access to a statement from the custodian to be able to verify the numbers are accurate from what the other plan providers are stating. The custodian’s statements are the most important for the employee have access to, as they are the accurate accounting of account values. Obviously online access to accounts and access through mobile apps can also be helpful in keeping employees informed and engaged.

What is their process for watching over the actions of the adviser and the record keeper/administrator?
Again, the custodian should take an active role in ensuring the plan is meetings it’s legal obligations and helping your company fulfill your responsibilities.

Proper Fiduciary Delegation can Reduce Liability

As the sponsor of a retirement plan, your company has a fiduciary responsibility (and liability) to protect the assets of the plan for the benefit of employees. This means your company can be sued and held legally liable for problems with your retirement plan.

Fortunately, you can reduce this liability by delegating some or most of your fiduciary responsibility to a qualified adviser. While you are always responsible for monitoring and managing 401(k) plan providers, your company liability can be significantly reduced through delegation under ERISA sections 3(16), 3(21), and 3(38).

Your Options for Delegating Fiduciary Duties

NO DELEGATION - YOUR COMPANY HAS FULL FIDUCIARY RESPONSIBILITY

Under this model, the plan sponsor (your company) makes the investment choices for the plan, functions as a prudent investment expert, ensures regulatory compliance, and retains full liability for any potential problems. A plan provider may offer a menu of proprietary insurance or mutual fund products, and may offer recommendations (not advice) from a non-fiduciary adviser, but your company is still fully liable.

Unfortunately, it is impossible to tell from the plan provider’s business cards or marketing materials whether they are acting as a fiduciary for the plan or whether you are reducing your fiduciary liability. Broker, insurance, and mutual fund company sales representatives generally have job titles like Financial Adviser and present their recommendations (sales pitches) as advice. Unless your company has executed a written agreement for the provider to take on fiduciary liability, the adviser may have no liability for the recommendations they make. Many companies believe they have delegated their fiduciary responsibility to their provider when in reality they have not.

3(21): CO-FIDUCIARY ADVISOR

Your company partners with a fiduciary advisor who offers true advice on the plan and in selecting investment options within the plan. This provides some protection for your company, but your company still retains full liability from exercising fiduciary discretion and acting as an investment expert.

The major benefit of 3(21) delegation is both you and the adviser are in the same boat for fiduciary liability, which reduces the chance you will get advice not in your company and your employee’s best interest.

3(38): DELEGATION TO A FIDUCIARY ADVISOR

Your company delegates authority in writing to a qualified fiduciary advisor who then makes discretionary decisions on the investment options within the plan. Your company can choose to fully delegate to the advisor, which shifts the company’s role from an investment expert to acting as a manager who monitors the investment expert. An advisor taking on the full 3(38) fiduciary status greatly reduces the company’s liability for investment decisions.

3(16) + 3(38): DELEGATION OF ADMINISTRATIVE AND INVESTMENT DUTIES

In addition to delegating the investment decisions, your company delegates the administrative functions of the plan. This includes the regulatory compliance, tax filings, and notifications required by law. Under this model, your company has reduced your fiduciary responsibility to managing and monitoring plan providers, shifting much of the liability for the retirement plan from your company to the providers you have selected.

Why Delegate Authority

While it is not necessary to delegate these responsibilities, there are obvious advantages to doing so. The reduction in company liability is the most significant advantage, but others also exist. Your company is much more likely to receive proper advice because the providers have taken on the fiduciary obligations. Instead of washing their hands of their advice by calling it a sales pitch in court, the providers are legally responsible for the advice they give. Additionally, your human resources department can focus on your employees, without having to be responsible for the details of the 401(k) plan.

You still have oversight

Additionally, delegating fiduciary authority does not take away any of your opportunities to watch over the plan and push providers to do the right thing. While you can’t tell a provider what to do, you can and should ask questions of the provider and demand they explain why they are making the decision they are. You can also make requests and recommendations to the provider and conduct benchmarking studies to compare your plan to similar plans. And you always have the power to fire providers if you feel they aren’t doing a good job.

A Tale of Two Legal Standards: Fiduciary & Suitability

The financial services industry is divided into two large camps. Those companies and advisers who are under the fiduciary standard and those who are under the suitability standard. While you would think an adviser would be required to do what’s in the client’s best interest, this is not necessarily the case. Only about 10% of people loosely called financial advisers are held to the fiduciary standard, while the rest are held to the much lower suitability standard as sales representatives.

Fiduciary Standard

Being a fiduciary means the adviser must offer advice in the client’s best interest and fully disclose and work to eliminate conflicts of interest. This provides incredibly greater protection for your company and your employees compared to the lower suitability standard. The importance of this difference can most easily be seen by the incredible amount of money the brokerage and insurance industries spent on fighting the DOL Fiduciary rule; $4.5 million in just the three months the Center for Responsive Politics looked at in 2015. Sadly, the rule was defeated in the 5th Circuit and the SEC ‘fiduciary rule’ being proposed doesn’t hold brokers or insurance companies to a fiduciary standard.

Two Types of Fiduciaries

Advisers who hold the CFP or other certifications are also fiduciaries, even though they are not legally held to the standard. The CFP board requires all of their certificants to take a fiduciary oath and to act as fiduciaries as defined by the CFP Board. The CFP Board, however, is quick to point out this is not a legal obligation. As a professional certification body, the most the CFP Board can do is take the CFP marks away from an adviser. While the CFP marks demonstrate the adviser has achieved a significant level of technical competence and professional expertise, they do not create a legal responsibility to their clients.

Currently only Registered Investment Advisers are legally held to the fiduciary standard. Unlike the CFP certification, being registered does not imply a certain level of professional expertise nor technical competence. Instead, it is a legal obligation to be held to the fiduciary standard in court disputes based on their licensing with the SEC. An adviser who is a Registered Investment Adviser will have disclosure filings, including a form ADV brochure, on the SEC website, such as this one. The Part 2 Brochure provides a plain-English explanation of the adviser and their business which can be used in court if the adviser violates their promises.

Your Legal Recourse if a Fiduciary Violates the Standard

When a fiduciary violates their legal obligation, you can hold them accountable for their actions, including suing them for the damages caused to you or your employees. Fiduciary advisers can also face losing their license, SEC fines, and potentially jail time if the violation is egregious enough.

Because fiduciaries are legally required to do what is in your best interest, it is much easier to sue them for advice which harmed your plan. This is an important function of the fiduciary standard because it creates an enforcement and punishment mechanism for bad actors who violate the trust of the adviser relationship.

Suitability Standard

The suitability standard is a much lower legal standard, meaning advisers can get away with a lot of questionable actions without being held accountable. The suitability standard says the adviser isn’t actually giving advice, but rather making a recommendation as part of a sales pitch. The recommendation also doesn’t have to be in the client’s best interest, but rather only has to be suitable to the client. So the recommendation can be in a higher cost, higher risk, or lower expected return investment than what is otherwise available. In fact, it is perfectly legal for the adviser to choose the investment that pays the highest commission as a part of their reason for the recommendation.

Further, advisers who are under the suitability standard don’t have a legal obligation to their clients, like fiduciary advisors do. Instead, they have a legal obligation to do what is in the best interest of their employer, which are the insurance companies, the stock brokerage companies, and the mutual fund companies. And sadly, these companies also don’t have a fiduciary obligation to offer advice in their client’s best interest.

While you can still try to sue an adviser who gives ‘bad’ advice, the extremely low bar of the suitability standard means the adviser can get away with a lot of very questionable actions and recommendations.

When a Fiduciary Doesn’t Have to Be

Another twist is that there are some advisers and companies who are licensed both as Registered Investment Advisers and as brokers or insurance agents. This allows the adviser (and company) to choose when they are giving advice under the fiduciary standard or when they give it under the suitability standard. There is no obligation for them to inform the client which standard they are operating under or when they decide to switch to the lower suitability standard.

What would you like added to this guide?

We are always looking to add resources to help the public advocate for themselves and understand their personal finances. If you have additional questions about offering a retirement plan that you would like answered, please let us know. We will do our best to answer your questions about choosing a 401(k) provider and add the information to this guide.


Help with your company’s plan

You can also learn more about the 401(k) plans offered by the author, Joshua Escalante Troesh. Through his firm he can help you with:

  • starting a 401(k) plan at your company

  • learning more about delegating your fiduciary responsibility or

  • exploring switching your current plan to a lower cost option


About the Author

Joshua Escalante Troesh is a Tenured Professor of Business & Entrepreneurship with two decades experience helping individuals with personal finance and entrepreneurship. He holds an MBA, has passed the rigorous CFP exam, and has been quoted in Forbes, U.S. News & World Report, The Street, Investopedia and other media.

Joshua owns Purposeful Strategic Partners, a Registered Investment Advisory firm specializing in advising on company 401(k) plans and offering financial planning for business owners. As a fiduciary financial adviser, he is held to the highest fiduciary standard in the industry. And as a fee-only planner he is only compensated by clients, eliminating the conflicts of interest which come  from compensation based on product sales, commissions, kickbacks, or other forms of hidden compensation.

Joshua began this work with a desire to continue educating and helping students from his Personal Finance classes. In 2016, Joshua created the Purposeful Finance website to allow students to ask questions about their finances. Purposeful Finance is now a 501(c)(3) Non Profit dedicated to providing free and low-cost financial planning resources to the public.

Quoted In:

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