401K: 3 Common Mistakes To Avoid

Written by Joanna Morrow

Joanna Morrow, Principal and Founder of Employer Benefits & Advice, is an employer consultant and advocate who has worked in the employee benefits industry for over two decades. She works diligently to help employers overcome obstacles in their business by sharing her expertise in Human Resources, Benefits & Compensation, Process Mapping, Risk Management and ERISA/DOL/IRS compliance. She is a licensed life and health insurance professional in the State of Arizona and is an active member of the National Association of Health Underwriters (NAHU).

401K: 3 Common Mistakes To Avoid

For a lot of people, a 401K plan is the best way to contribute to a retirement plan.

Sponsored by the employer a 401K allows employees to save and invest a piece of their paycheck on a pre-tax basis. Taxes aren’t paid until the money is withdrawn from the account.

Done right, a 401K offers a win-win for both employer and employee. Not only does it make your compensation package more attractive, it offers employers certain tax savings and incentives.

Unfortunately, when it comes to employee benefits the 401K plan doesn’t fight for the employer’s attention the way medical and general liability contracts do each year. It doesn’t renew on an annual basis and in most companies it bubbles along on the back burner of compensation priorities until one of your employees sues you for breaching your fiduciary duties.

In preparing for the DOL Conflict of Interest Rules soon to take effect, employers can protect themselves by avoiding these 3 common mistakes in 401K administration.

#1 – Failure To Understand Roles & Responsibilities

Fiduciary: Who is the named fiduciary listed on your 401K plan? A plan must have at least one fiduciary (a person or entity) named in the written plan. The person who has a fiduciary duty is called the fiduciary, and the person to whom he owes the duty, is typically referred to as the principal or the beneficiary.

A fiduciary duty is the highest standard of care and the one to which all employers are held. After all, this is retirement income you’re playing with. A plan’s fiduciary will generally include:

  • All individuals exercising discretion in the administration of the plan, including the employer
  • The trustee
  • Investment advisors

With everyone from your payroll vendor to your insurance broker claiming to be able to offer you a 401K plan – it can be difficult for employers to determine if they are dealing with a vendor that at the very least, is held to the same standard as the employer.

However, there are some key distinctions of which employers need to be aware:

Brokers (Registered Representatives of a Broker Dealer):

  • Paid commissions from recommended investments
  • Regulated by (Financial Industry Regulatory Authority) FINRA
  • Held to a “suitability” standard:
  • Translation: Instead of having to place his or her interests below that of the client, the suitability standard only details that the broker-dealer has to “reasonably” believe that any recommendations made are suitable for clients, in terms of the client’s financial needs, objectives and unique circumstances. A key distinction in terms of loyalty is also important, in that a broker’s duty is to the broker-dealer he or she works for, not necessarily the clients he serves.
  • The DOL Conflict of Interest Rule that goes into effect April, 2017 will see many brokers attempting to protect this lucrative area of their commission-driven business by encouraging their clients to sign “Best Interest Contract Exemption” (BICE) documents to skirt the conflict of interest rule.

Registered Investment Advisor (RIA):

  • Paid a fee based on percentage of plan assets under management
  • Regulated by the Securities and Exchange Commission (SEC)
  • Held to a “Fiduciary” standard, just like the employer
  • Translation: A fiduciary standard requires advisors to put their client’s interests above their own. It consists of a duty of loyalty and care, and simply means that the advisor must act in the best interest of his or her client. It also means that the advisor must do his or her best to make sure investment advice is made using accurate and complete information, or basically, that the analysis is thorough and as accurate as possible. Avoiding conflicts of interest is important when acting as a fiduciary, and it means that an advisor must disclose any potential conflicts to placing the client’s interests ahead of the advisors.

Most Common Employer Mistake: Making the assumption that your service providers are being held to the same fiduciary standard as you are.

Many employers mistakenly believe they are partnered with an equal when it comes to their investment advisor. Because employers are held to a fiduciary standard a best practice is to ensure that you are working with an investment advisory firm that is also bound by a fiduciary standard. The new Conflict of Interest Rule clearly distinguishes between financial education and financial advice, and employers should be working with only those service providers licensed to deliver the latter.

 #2 – Lack of Documentation

Each retirement plan has certain key elements. These include:

  1. A Written Plan – describes the benefit structure and guides day-to-day operations
  2. A Trust Fund – to hold the plan’s assets
  3. A Record Keeping System – to track the flow of monies going to and from the retirement plan
  4. Documents – to provide information to employees participating in the plan and to the government.

Most Common Employer Mistake: Failure to document fiduciary decisions.

Prudence focuses on the process for making fiduciary decisions and therefore it is wise for employers to document the basis for fiduciary decisions such as evaluating and diversifying plan investments. Many employers do not keep a thorough, documented record of such decisions which puts them at risk in the face of an audit.

 #3 – No Formalized Process For Selecting Service Providers

The right investment advisor can offer considerable peace of mind for both employer and employees by offering sound investment advice while ensuring the employer is in compliance with ERISA requirements. The most common complaints I hear from employers and employees directly relates to weakness in these areas. Employers will often drop the 401K citing “no one understood it” or “we couldn’t get participation” which is always indicative of a service provider who dropped the ball.

When selecting a provider, employers should ask specific questions about the firm itself, quality of the services offered, a description of their business practices as well as an opportunity to review sample service agreements, employer reporting and employee communications.

Most Common Employer Mistake: Failure to issue a formal Request for Proposal (RFP).

A formal RFP can help you select the best candidate for the job.

If you’re thinking of offering a 401K or wish to make changes to your existing one, a formal approach to vetting the best service provider is one of the best things you can do for yourself. For an idea of the types of questions you should be asking, download my sample 401K Vendor RFP here.

For more information on how you can tighten up and develop best practices in 401K administration, contact me.