Do You Know What You Are? ERISA
Posted on September 16, 2011 by Keith R. McMurdy
The questions may sound like the title to a Dr. Seuss book, but it really has great bearing on how to you are treated under ERISA. Knowing your title also creates clarification as to what your duties are, and what they are not.
Take the term "plan administrator." The plan administrator is the person responsible for managing the day-to-day operations of the plan. The plan administrator is designated in the plan the plan documentation as administrator. If no one is otherwise designated, the plan administrator is the plan sponsor (unusually the employer). This was relevant in a recent decision finding that an plan sponsor (employer) was not liable for the failure to send a COBRA notice because COBRA requires the plan administrator to send notices, and the plan designated an insurance company as the plan administrator. So if the duty is on the plan administrator, then you need to know if you are a plan administrator.
But plan administrator may not be the same as "claims administrator." This would be an entity that processes claims, but may not necessarily administer the plan. So designating a claims administrator would not be enough to name someone other than the employer as the plan administrator.
Similarly, "plan sponsor" is just that, the entity that sponsors the plan. This could be the employer or an organization or a group of employers. But status as a plan sponsor or status as a "fiduciary" can be different. Particularly when evaluating the difference between decisions that implicate settler functions (such as the decision to terminate a benefit plan) and those that implicate plan administration functions (such as the obligation to provide appropriate notice about the termination of a plan). Of course, "fiduciary" has its own distinction. A fiduciary in ERISA terms is someone designated s such by the plan, or someone who exercises "discretionary authority" over the administration of the plan. Fiduciaries have specific responsibilities to the plan beneficiaries and can be sued for "breach of fiduciary duty."
The point of this post is not to answer definitively what you are, but to make sure you know to ask what you are. The point is what you are matters. If you are an employer with a benefit plan, you are one and may be all of the above. What you are defines your risks and responsibilities. So if you have questions about what you are, ask your attorney at Fox Rothschild.
401(k) Deferral Elections for Partners, Sole Proprietors & LLC Members
Owners of partnerships, sole proprietorships, limited liability companies or partnerships (LLC's or LLP's) do not receive W-2 wages. We will refer to these individuals as "owners." Most owners take money out of the company during the year but do not pay taxes on those amounts at the time it is paid. They may pay estimated taxes during the year or pay the taxes when they file their tax returns after the end of the year. The question is, when are the owners of these businesses supposed to elect their 401(k) deferrals and when are they supposed to deposit their 401(k) deferral contributions when they don't know what their net earnings will be until after the end of the plan year?
401(k) Elections - owners of these types of entities should make a 401(k) deferral election by the end of the plan year (usually December 31). They can select a dollar amount, a percentage or a formula (i.e. 15% of net income).
Timing of deposits - we recommend that these individuals deposit the money as soon as they can, either during the plan year or right after the end of the plan year. If owners do not know whether they will have net income in excess of the maximum 401(k) deferral limit plus their share of any employer contributions, they can wait to make a deposit until they know what their net income is for the applicable tax year. Once they know their net income, however, they should make the deposit immediately. Small plans (generally plans with fewer than 100 participants) should deposit 401(k) deferrals into the plan no later than 7 business days after their net income is determined. This timing is pursuant to the Department of Labor's safe harbor 401(k) deposit rules issued in early 2010 for smaller plans. Please see our article about the 7 day safe-harbor rule. Owners should have a fairly good idea of their net income by April 15th each year, even if they have to file an extension for the business tax return. If the IRS audits the plan and determines that the contribution was not made timely, like employee 401(k) deferrals that are deposited late, the amount involved is considered a prohibited transaction and penalties will apply.
Fiduciary Rules Related to Automatic 401(k)s
By Robert J. Toth
An employer adopting an "automatic 401(k)" does so by either adding automatic features such as automatic enrollment to an existing 401(k) plan, or by newly adopting such a plan. Either way, the plan sponsor needs to be familiar with the fiduciary obligations that come with these arrangements, generally referred to as Automatic Contribution Arrangements (ACAs). Fortunately, Congress has simplified the manner in which some of these obligations can be met, making it more attractive to adopt an automatic 401(k) plan.
The fiduciary rules which apply to private employers maintaining a 401(k) plan---or a 403(b) plan, which is governed by ERISA---and and an automatic 401(k) for its employees can, at first glance, seem intimidating. However, the rules are based upon the exercise of sound business judgment, as opposed to a set of rigid standards. As long as plan fiduciary decisions are soundly made, and are made for the exclusive benefit of the plan participants, the fiduciary's exercise of judgment will receive deferential treatment. If the decisions are made as part of a considered process, the fiduciary will likely be protected even if, in hindsight, the decision proves to be wrong.
It is also important to remember that not all decisions related to a defined contribution plan generally, or an automatic 401(k) plan specifically, are considered fiduciary decisions. For example, the decision to adopt a 401(k) plan, or the choice of the type of automatic 401(k) to use, are business decisions that can be made in the best interest of the employer---the interests of the plan participants do not have to be legally taken into account. On the other hand, the implementation of some aspects of that business decision, such as hiring service providers or choosing investments, often involve fiduciary decisions.
The following will assist the employer in sorting through these rules, and how they will apply.
Fiduciary Obligations Related to All Plans
Before discussing the particulars of the fiduciary rules as they apply to automatic 401(k) plans, it is helpful to first go over the workings of fiduciary rules generally.
Whether or not an employer decides to adopt an automatic 401(k) as part of their 401(k) or 403(b) plan, there are certain basic rules of conduct which apply to the way in which those plans are administered and the funds invested. These rules are called the "fiduciary " rules under ERISA, and are based upon the ancient law of trusts. Under these rules, often described as the comprising the greatest legal duty one person can owe to another under law, one person is obligated to act only in the best interests of another when making decisions related to the plan.
The fiduciary rules that apply to all plans establish a "Prudent Person" standard of care. These prudence rules apply both to the administrative decisions made under the plan as well as to the decisions related to plan investments.
There are four basic fiduciary rules. A fiduciary must:
These four rules are very broad, and are short on specifics. This is because they are designed to outline the manner in which a fiduciary's judgment should be exercised, not to provide specific guidance as to what any particular decision should be under a plan. The rules rely heavily on---and defer to---an individual's judgment, well exercised, and the process by which decisions are made.
As previously mentioned, the courts have called these ERISA's fiduciary standards the highest standard of duty that one can owe to another under law, as plan fiduciaries must completely discount their own interests when making plan-related decisions. In return for being held to this high standard, however, the decisions of the properly acting fiduciary will be granted deference by the courts. The fiduciary's decision can be wrong under this standard, but, as long as it is arrived at properly, the fiduciary will not be considered as breaching its duty.
Who Is a Fiduciary?
A fiduciary, generally speaking, is someone who exercises discretionary authority over a plan or its investments, or someone who regularly gives investment advice to a plan for a fee.
A person becomes a fiduciary in one of three ways:
Every plan must have a "Plan Administrator," who has the fiduciary responsibility for administering the plan properly. It must also have a "chief" fiduciary (sometimes referred to as the "named fiduciary") who has the authority to appoint all of the other fiduciaries to the plan, and who is responsible watching over plan investments. In the absence of the plan sponsor or appointing someone (or appointing a committee) to fulfill these responsibilities, the plan sponsor itself will be considered the fiduciary and be held to the fiduciary duties outlined above. This then means that corporate officers or members of the board of directors may be considered fiduciaries as well, because of their responsibilities to manage the company.
A fiduciary can also delegate its responsibilities to another willing party. For example, if the plan document states that the "plan administrator" is responsible for managing a plan's assets, that administrator can delegate that responsibility to an investment manager. Likewise, a plan fiduciary that has little experience with investments can hire an investment advisor who will serve in that fiduciary capacity.
When these delegations of authority are assigned, it should be done in writing. Whenever fiduciary obligations are delegated to another party, the person delegating that authority still retains a "residual" responsibility to periodically look over the shoulder of the appointee to make sure they are properly fulfilling their delegated responsibility.
It is important for plan sponsors to understand that fiduciary obligations under ERISA are generally considered to be personal obligations. This means that, even though the plan sponsor is a corporation which will be deemed to be considered the Plan Administrator (which is a fiduciary position), it is actually the officers or board members of the company who may bear that personal responsibility unless someone else is specifically delegated that authority. This makes it important that the company paperwork specifically identify the officer (or, at least, the title of the person) or appoints a committee which will be named the fiduciary. Failing to name the fiduciary could result in board members or senior officers being inadvertently labeled as fiduciaries.
The Value of Process and Documentation
ERISA's prudence standards really boil down to process. If a fiduciary follows a good process when making a decision, the courts will generally defer to that decision even though in hindsight the decision may have been wrong1. The elements of a sound ERISA process include:
The fiduciary standards do not require that a committee be appointed in order to follow this process, but a committee makes the process much easier to follow and for the decisions to be documented.
Role of the Advisor
The registered investment advisor can play an important role with regard to the plan's investments. An advisor who regularly provides investment advice for a fee to another plan fiduciary, or one who has discretionary authority over the management of a plan's assets, will be considered a fiduciary. An investment fiduciary will be personally liable for the prudence of the advice he or she gives, or for the management activities in which they engage. However, an investment advisor or manager who is appointed a fiduciary only has obligations to the extent of the authority it exercises. This means that an investment fiduciary will not be responsible for the fiduciary acts of, for example, the fiduciary who is responsible for making administrative decisions under the plan.
A fiduciary must avoid using a plan's assets for its own personal benefit, and ERISA has a series of rules which are designed to prevent this. These rules are called the "prohibited transaction" rules. A fiduciary that uses the assets of a plan (such as taking a corporate loan for the plan sponsor's business from the plan) is required to report such transactions and undo any transaction which was prohibited. A fiduciary that misuses plan assets can be subject to tax and civil penalties which can range up to 100 percent of the amount involved in the prohibited transaction.
DOL Fiduciary Resources
The United States Department of Labor has a number of resources that can be used by plan fiduciaries in meeting their fiduciary obligations including:
The fiduciary rules apply in a very particular way to ACAs. The rules are
designed to help lessen the burdens and exposures which otherwise may apply to
employers adopting these arrangements.
First of all, companies that have adopted---or are thinking of adopting---an automatic 401(k) should be aware of a key point: Not all decisions about ACAs are fiduciary decisions. For instance:
On the other hand, choosing the default investment for any ACA is a fiduciary act.
Choosing a Default Investment---a
Default investment selection for an automatic 401(k) is a decision which must be made in accordance with the fiduciary standards described above. A financial advisor can assist you in properly choosing an appropriate default investment fund.
Fortunately, Congress considered this, and provided plan sponsors some fiduciary relief when adopting such a fund for an ACA. This protection takes the form of allowing the plan sponsor to adopt a certain type of default investment option which will be treated as if it were actually chosen by the plan participant. Under ERISA, this means that, as long as certain rules are met, the fiduciary will not be held responsible for investment losses from the default investment into which the automatic 401(k) contribution was placed.
With this rule, the fiduciary's choice of a default investment will be deemed to be an investment choice made by the plan participant in an ACA if the contribution is invested in a Qualified Default Investment Alternative (or QDIA), as described below. This is meaningful protection for the fiduciary. Courts have recently ruled that plan participants who have suffered significant losses from a QDIA cannot hold a fiduciary liable for these losses as long as the above steps have been taken.
QDIA as a Default Investment
The plan sponsor may choose to use the QDIA as a default investment fund in order to take advantage of the fiduciary relief provided by Congress. However, the choice of which QDIA to use is a fiduciary decision which must be prudently made in accordance with the fiduciary standards described above. So even though the employee is treated as choosing the QDIA (with the employer not being held liable for that choice if it results in losses), the fiduciary's choice of the actual QDIA is considered a fiduciary choice. If that choice is made imprudently, the fiduciary can be held liable for losses.
In addition to following the general fiduciary standards in choosing a QDIA, the QDIA must, according to the Department of Labor, also be one of these four types of investments:
The following rules must also be met in order to qualify as a QDIA:
The timing requirements of the QDIA notice are not identical to the timing
requirements for an ACA notice, but an employer can satisfy both sets of rules
simultaneously if carefully coordinated.
While it is not required that a QDIA be used as a default fund, should a fiduciary choose a default fund other than a QDIA, the participant will not be treated as being the person making that investment choice, therefore increasing the fiduciary's potential liability.
Finally, the fiduciary rules described above only apply to automatic contribution arrangements, which are subject to ERISA. Governmental plans, some church plans and 403(b) plans that are not subject to ERISA are instead governed by state and local. Check in with a lawyer when dealing with non-ERISA plans to determine what fiduciary-like rules may be applicable to these arrangements.
Now is the Time for Retirement Plan Decisions
Many successful companies (especially professional firms like medical groups and law firms) are considering whether to increase retirement plan deductions for 2011. This post highlights the action steps to take while there's still time.
Note: We'll be focusing on cross-tested profit sharing plans and cash balance plans. These plans allow owners to make large tax-deferred retirement contributions in exchange for providing a generous employee retirement allocation (usually 5% of pay if there's only a profit sharing plan, or 7.5% of pay if there's a cash balance plan too).
1. Get educated before diving in. Before setting up a retirement plan, you need to understand all of the rewards, risks, and costs. Our "Eyes Wide Open" post is a great place to start. You can also find lots of information by googling a phrase like "cash balance plan FAQ".
2. Know your deduction goals and be realistic. There are various levels of deductions available in an employer-sponsored retirement plan. Move on to "the next level" only if you have maximized lower-level deductions. We've written an article that summarizes the "big, bigger, and biggest" retirement plan deduction opportunities.
You should work with a qualified retirement plan consultant to analyze which options will work best for you in the long run (e.g., if income varies significantly from year to year, then profit sharing is better than a cash balance plan). A recent onwallstreet.com article provides a good summary of the pros and cons of different retirement plans along with examples.
3. Get started now. If you want to set up a plan and make deductions for 2011, then it must be in place (with a signed plan document) by December 31. For profit sharing and cash balance plans, you'll have until until September 15, 2012 to make contributions for the 2011 plan year.
If you're focusing on a new plan for 2012, it's still a great time to get the ball rolling. Having a plan in place early in the year ensures that you have more time to set aside assets to contribute. It's especially important to get a safe harbor 401(k) plan [which often complements a cash balance or profit sharing plan] set up now because IRS rules require you to notify employees at least 30 days before the new year (i.e., by the end of November).
Profit sharing and cash balance plans can be great tools for business owners to make significant tax-deferred retirement contributions. The deadline for establishing a plan in 2011 is fast approaching, so now is the time to take action.
Best Practices for Reducing Loans, Hardship Withdrawals, and Impulsive Investment Decisions
By Liz Davidson, founder and CEO of Financial Finesse.
Negative behaviors such as using the 401k plan as an emergency fund instead of a long-term retirement savings account and taking excessive loans and hardship withdrawals is a symptom of a bigger problem among the employee population. The same is true for impulsive investment decisions that could ultimately delay employees' retirement. When employees try to time the market instead of sticking with time tested investment strategies such as asset allocation, rebalancing, and dollar cost averaging, their investment performance suffers. Effective employer solutions treat the root cause of the problem rather than focusing on the symptoms.
Employees who take 401k plan loans contribute less for retirement. According to the Aon Hewitt study Leakage of Participants' DC Assets: How Loans, Withdrawals, and Cashouts Are Eroding Retirement Income, employees with loans have an average contribution rate of 6.2% while employees without loans contribute on average 8.1% to their defined contribution plans. This difference in contribution rates could mean tens of thousands of dollars to participants in retirement. The study also noted that withdrawals (including those due to hardship ) have a great impact on retirement income as well, noting that full-career contributors who take withdrawals and stop contributing for two years thereafter reduce their retirement income by 7% to 25% depending on income and enrollment methodology.
Investment timing can negatively affect investment performance, but many employees don't know what else to do when they don't understand basic investment strategies. A recent study by Fidelity Investments® showed employees that moved all of their funds out of equities during the recession of 2008 - 2009 experienced an average increase in account balance of only 2% through June 30, 2011 while those who maintained their investment strategy realized an average account balance increase of 50% during the same period. Reducing impulsive investment decision making and encouraging strategic decision making will improve retirement preparedness along with employees' investment confidence.
This is a problem that could come back to haunt employers. There is a growing concern that lawsuits from employees who claim they weren't given enough information on how loans, hardship withdrawals, and poor investment choices could severely impact their retirement may increase. The claim may be that employees shouldn't have been allowed to take loans or hardship withdrawals, or that they should have been given more information on asset allocation.
Employers that offer a well designed plan that includes financial education as a level benefit with easy access for all employees can reduce these negative behaviors, can help their employees to have a more secure retirement, and can reduce the likelihood of lawsuits in the future. Excessive loans and hardship withdrawals are caused by employees' poor cash management and excessive debt. If an employer attempts to use only plan design to solve the problem, the employees may perceive the plan as too harsh and the company as "big brother" trying to steer their behavior. Education alone may be effective for the employees who make full use of the education but may miss the employees who don't utilize the education. A combination of plan design and financial education works well to improve employees' financial wellness by casting a wider net in order to help employees help themselves without feeling pushed.
Best practices to reduce excessive loans:
Best practices to reduce hardship withdrawals:
Best practices for reducing impulsive financial decisions:
There is a delicate balance that must be struck.
Employers that put too many constraints on plan design may have employees who
feel their employers are too involved in their decision making and resent it. At
the same time, plan design can be very effective at shaping employee behavior.
Pairing appropriate plan design with financial education can strike the right
balance by encouraging good behavior in employees while protecting the company
at the same time.
Too many workers leaving 401k matching dollars on the table
By Larry Barrett
October 19, 2011
Financial Industry Regulatory Authority, Inc. this week issued an investor alert urging the roughly 30% of American workers who are not contributing enough to their 401(k) plans to receive a full employer match to step up their contributions in order to meet their eventual retirement needs.
The alert, titled "Why Leave Money on the Table - Make the Most of Your Employer's 401(k) Match - claims that too few workers are taking advantage of a simple benefit that can pay large dividends when investors reach retirement age. One of the most common matches is a dollar-for-dollar match of up to 3% of the employee's salary.
"Even in tough economic times, all employees still need to prepare for their retirement. Taking full advantage of a company's 401(k) match is a no-cost way for workers to boost their retirement savings," Gerri Walsh, FINRA vice president of Investor Education, said in the alert. "Employees who contribute less than their employers are willing to match are walking away from free money."
FINRA officials said younger workers are even more likely to leave money on the table, with 43% of workers age 20-29 failing to contribute to the full extent of their employer's match. An earlier study showed that 40% of employees making less than $40,000 fall short of contributing the full extent of their employer's match.
"Millions of workers, especially younger and lower income workers who need it most, are leaving money -- free money -- on the table," FINRA said.