Administering a 401(k) plan for your employees can sometimes feel very confusing – especially if you’re a small business owner. If you offer the plan as an employer, you’re probably a fiduciary to it. That means you’re responsible for acting in the best interests of all the participants. For example, you cannot offer investment choices that you know are bad (like restricting investments to all but one stock in your friend’s company). Such an egregious violation would be a breach of fiduciary duty.
However, most “breaches” aren’t of this nature. They happen because business owners wear multiple hats. Just because you sponsor the plan, doesn’t mean you know the best investment choices to offer or why specific investment options are better.
While you may be just fine running the plan on your own, the reality is that you do open yourself up to potential legal trouble if something happens. If an employee can claim that you breached this duty, you could face a lawsuit. Therefore, many people choose to outsource this job to experts. The problem is that there are multiple types of fiduciaries. There are 3(16), 3(21), and 3(38) fiduciaries, and many people select one without realizing it doesn’t provide the protection they need.
Therefore, if you need help fulfilling your fiduciary duties (or you want to reduce liability), here’s a breakdown of what the fiduciary categories are and which ones can help!
3(16) Fiduciary
A 3(16) fiduciary handles the administrative functions related to a 401(k) plan. This fiduciary ensures that the program conforms to the criteria in the Employee Retirement Income Security Act.
The duties of this job tend to be vague. The Act specifies the fiduciary responsibilities for administrators, but it doesn’t do so explicitly. Typically, a 3(16) fiduciary will have whatever duties are in the plan document and, as such, the roles of two of these fiduciaries will seldom be identical.
It is worth noting that the 3(16) role is relatively new, and it will usually not protect employers from liability. Still, it will make your life easier in that disclosure requirements, plan descriptions, and Form 5500 filings will no longer be your responsibility.
3(21) Fiduciary
A 3(21) fiduciary is an advisor that provides investment advice or manages the plan’s assets. This fiduciary will make investment recommendations and guide what funds should be in the plan’s menu.
However, a 3(21) fiduciary will not make the final determinations. That’s the role of the plan’s sponsor – which is you. As such, you’re still responsible for all final investment decisions, which makes you liable in the event of issues.
A 3(21) fiduciary is beneficial because it helps you make better decisions about how your plan should operate and what should happen. That, in turn, reduces your liability indirectly. Or, perhaps a better way to phrase it is that it reduces the likelihood that something would go so catastrophically wrong that you would be the target of a successful lawsuit. In theory, expert guidance would help you make sound decisions.
3(38) Fiduciary
Finally, the last category of 401(k) fiduciary is the most “protective” of them all. This fiduciary is an advisor that has complete control over your plan’s investments.
The fact that this advisor will have full control means that they also assume most of the liability. If things go wrong, you’re not the target of a lawsuit. Instead, the 3(38) fiduciary is. You still have some liability because you have a fiduciary duty to pick a qualified 3(38) fiduciary. And you have to continue to monitor their decisions to ensure they are making the right calls. But, for the most part, you absolve yourself of most responsibility when it comes to your company’s 401(k) plan.
401(k)s Are Complicated: Outsourcing Responsibilities Often Makes Sense
As you can see from the fact that there are three fiduciary categories for 401(k)s, creating a fair, equitable, and responsible 401(k) plan is sometimes trickier than it looks. It’s easy to run afoul of the law.
For example, providing too generous matches to highly-compensated employees and not enough to ordinary employees can quickly run afoul of the IRS. To avoid this, employers can create a Safe Harbor 401(k), which has the primary requirement that employers must make contributions and those contributions must vest immediately.
By selecting fiduciary experts for your 401(k), you’ll avoid costly corrections, lots of paperwork, and potentially even needing to refund contributions (which is tough to explain to employees). If you want to ensure you’re doing your 401(k) right, consider one of the fiduciary types above. We would be happy to help provide exceptional 3(21) and 3(36) fiduciary services to your plan!
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