Retirement plans offer various benefits to employers and their employees. Although the Employee Retirement Income Security Act (ERISA) of 1974 has set guidelines and long-imposed standards for those who manage these retirement plans, the governance of these plans has attracted media attention and several litigations from organizations and retirement plan participants. Because of this continuous scrutiny, it is critical that plan fiduciaries completely understand their roles and responsibilities and comply with all the rules, regulations, and standards applicable to them.
A fiduciary, in common terms, is a person who has a duty of care and trust towards another person and should act primarily for the benefit of others for an agreed set of activities. In terms of retirement plans, the law defines the tasks that require fiduciary duties and the extent of those duties.
There are various tasks that require hiring a fiduciary for operating a qualified retirement plan, such as whether to appoint someone to manage the plan or do it in-house. Taking full control of the plan assets or using discretion in managing the plan makes the plan sponsor or the entity it hires a plan fiduciary to the extent of that discretion or control. Fiduciary status is based on the tasks at hand for the plan and not a title. In fact, hiring a third party to perform fiduciary functions is itself a fiduciary act.
However, not all plan decisions are related to fiduciary; some are business-related. For example, the decisions to set up a plan, add features, make changes, or terminate a plan are all business decisions. When a plan sponsor makes these decisions, they act for their business, not the plan. Therefore, they do not count as fiduciary decisions. However, when steps are taken to implement these decisions, the plan sponsor acts for the plan as a fiduciary.
Types of fiduciaries
- Named fiduciaries: For every plan, there must be one or more ‘named fiduciaries’ who have the authority to control its operation and administration. The plan document must mention the named fiduciary or pursuant to a procedure specified in the plan. Additionally, ERISA defines other roles such as investment manager, plan administrator, discretionary trustee, and investment advisor as fiduciary roles.
- Functional fiduciaries: An individual who is not acting as a ‘named fiduciary’ may still be a fiduciary as per ERISA’s fiduciary definition to the extent he/she:
- Has any kind of discretionary authority or discretionary control over the management of a plan or the disposition of its assets
- Offers investment advice to plan participants in exchange for a fee or has any authority or responsibility to do so
- Has any discretionary authority or responsibility over the administration of a plan
- Common fiduciaries: These are employers / plan sponsors who maintain plans and are typically fiduciaries, either due to their being named fiduciaries or acting as functional fiduciaries. In these cases, the employer acts in a dual capacity – a fiduciary to the plan and an employer.
401(k) plans, which are also the most common types of retirement plans offered by companies, work with three types of fiduciaries: 3(16), 3(21), and 3(38). The ‘3,’ which is common in 3(16), 3(21), and 3(38), is derived from Section 3 of ERISA, which contains the rules and defines fiduciary roles into three separate sections, with 3(16) fiduciaries overseeing the administration of the plan, 3(21) fiduciaries making investment recommendations, and 3(38) fiduciaries managing investments.
Basic roles and responsibilities of a fiduciary in retirement plans
ERISA defines fiduciary duties that are applicable and relevant to retirement plans. These duties include:
- Acting solely in the interest of the participants and beneficiaries: Fiduciaries should only make decisions in the best interests of the retirement plan participants and beneficiaries, not the ones beneficial to them or others.
- Acting for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of the plan: Anybody who acts in a fiduciary capacity should not use the plan’s assets for any purpose other than providing benefits to plan participants and beneficiaries or defraying reasonable expenses of the plan.
- Carrying out their duties with care, skill, prudence, and diligence: Fiduciaries must fulfill their roles to the best of their abilities and as if they are managing their own assets.
- Following the plan documents: Fiduciaries are required to abide by all terms of the plan document, and any applicable laws and regulations.
- Diversifying plan investments: Fiduciaries must focus on diversifying the plan’s investments to minimize risk and maximize returns.
Considerations and factors while choosing an external fiduciary service provider
- Fees: The fees can vary a lot from one fiduciary services provider to another. It is imperative to seek and compare the fee structures of different providers to ensure that the employer is getting the best deal.
- Services: Different fiduciaries offer different services. For example, some providers only offer plan design and administration, while others also offer investment management and participant education. Therefore, employers should select a provider as per their own needs and requirements.
- Experience and affiliations: The employers should weigh the benefits and risks of an experienced provider, who has been in the business for many years with a ton of experience, vs. newer ones, who might be cheaper and might offer more innovative services. Other things to consider include the firm’s affiliations, financial condition, and assets under their control.
- Investment strategy: Evaluate how the firm plans to invest its assets or how it will handle participant investment directions.
- Reputation: The reputation of the provider is also an important consideration. The employer should conduct some background research before engaging with a provider.
Top Asset and Wealth Management (A&WM) companies offering fiduciary services for retirement plans and why
Several prominent players, such as Vanguard, Fidelity, Charles Schwab, T. Row Price, Principal Financial, and Betterment, offer a variety of services, including plan design, administration, investment management, and participant education. They can also help in complying with ERISA and other applicable laws and regulations. Some of the examples include:
Reasons why top A&WM companies provide fiduciary services:
- To comply with regulatory requirements: ERISA requires fiduciaries to manage plans in the best interests of participants and beneficiaries. It means that they must act prudently and avoid any conflicts of interest. A&WM companies can help clients comply with ERISA regulations and other applicable laws and guidelines.
- To have an edge over their competitors: The retirement industry is increasingly becoming competitive, and top A&WM companies are looking for ways to differentiate themselves from their competitors. By providing fiduciary services, they not only expand the breadth and depth of their services, but also demonstrate commitment to prioritizing the interests of their clients.
- To provide peace of mind to clients: Many clients have concerns regarding potential conflicts of interest when they engage with a financial advisor. Sometimes, clients also doubt if the best products are being offered to them or those that are more profitable to advisors. By offering fiduciary services, A&WM companies can address these concerns and assure clients that their interests are being put first.
This topic has become critical over the years
The topic of fiduciaries has come under the radar in the retirement plan industry recently for several reasons, including:
- Retirement plans becoming more complex: The complexity of retirement plans has increased in recent years due to a wide variety of investment options being offered and more intricate tax rules. Therefore, plan participants need guidance and support to make informed decisions about their retirement savings.
- Increased demand for fee-only financial advisors: Fee-only financial advisors are in demand these days from investors and plan participants. These advisors charge fees for their services instead of commissions from the sale of products. Such advisors have a fiduciary duty to their clients, as they do not earn based on the products they sell.
- Ever-growing number of lawsuits: In recent years, the number of lawsuits against fiduciaries for failing to meet their duties has grown multifold. These lawsuits depict the importance and absolute need of fiduciaries to act in the best interests of plan participants and beneficiaries. Fiduciary breaches, specifically, can result in severe consequences such as:
- Legal and financial ramifications: Significant penalties, including fines, lawsuits, and even criminal charges, can be imposed.
- Adverse impact on plan participants: When fiduciary duties are breached, end results can reduce the retirement savings of plan participants and lower financial security.
- Reputational risk: Fiduciary breaches can result in severe reputational damage for the fiduciary and the organization they represent. It can make attracting potential and retaining existing employees difficult.
- Remedies and corrective actions: When a fiduciary breach occurs, appropriate remedial and corrective actions need to be taken to address and control the situation and prevent future occurrences.
Considering all these factors, it is important for fiduciaries to fully understand their duties and take appropriate steps to discharge them. Also, the increased spotlight on fiduciary duties in the retirement plan industry is a positive trend, as it ensures that retirement plans are managed efficiently, and that plan participants and beneficiaries can meet their retirement goals.
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