Guide Summary

Table of Contents

1. Importance of Choosing the right providers

2. 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

3. Reducing Your Liability through Fiduciary Delegation

4. Protecting Your Plan & employees - The Fiduciary Standard

5. Getting Additional Help & About the Author

Choosing the Right 401(k) Provider

Choosing the wrong 401(k) provider can significantly diminish employees’ retirement savings and open your company to legal liability. 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, make sure to understand your options to avoid the dangers to yourself, your company, and your employees.

Side Note on The Solo-401(k)

For small business owners considering Solo-401(k) plans, the Solo-401(k) is simply a marketing term for a 401(k) plan where the only participants are the business owner and their spouse. Solo-401(k) plans, by their nature, do not provide the same creditor protections as “normal” plans do. This should be a major concern for business owners, especially those in liability-prone industries. I will often strategize with clients on how to structure their business and the plan to offer full ERISA coverage. The best 401(k) plans will provide you with full ERISA creditor protection for the same cost as a Solo-401(k). [Author’s note: I happen to think our plans are among the best 401(k) providers].

The Solo-401(k) provides minor benefits and carries with it significant drawbacks. Aside from the liability issues, the plan will apply to future employees when you hire or expand. If you are considering a ‘Solo-401(k) plan,’ get advice from a fiduciary 401k plan advisor. If a Solo-401(k) is not designed with company growth in mind, there could be significant cost and legal implications down the line.

The Danger of a poor 401(k) Plan

Stock brokerage, insurance, and mutual fund companies can all offer 401(k) plans; but may not be the best choice for your company and employees. Unfortunately, many of the national name-brand companies set up 401(k) plans as massive cash cows that can deliver significant profits to the providers. Questionable practices are surprisingly common in many 401(k) plans including:

• High administration fees

• Poor investment options

• High-cost funds (with kickbacks to the provider)

• Self-dealing practices

• Commissioned sales

About the Author

3 Main 401(k) Provider Functions

Operating 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.

Plans where three separate companies handle each function 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, the adviser can hold each company accountable for keeping fees down and protecting the client, assuming there are no back-end revenue-sharing agreements between the companies and the adviser. As an example: with the 401(k) plans I provide, my compensation comes 100% from the employer or the employees within the plan, so there is no incentive for me to increase any other company’s profits. Instead, independent advisors like myself have an incentive to switch custodians or administrators if their fees get too high or if they 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 structure of the plan, how the fees are charged, and the investments you should have in your plan. These recommendation will be true advice only if the advisor is a Registered Investment Advisor. If the advisors is a stock broker or an insurance agent, the ‘advice’ will legally be a sales pitch (not true advice) and the advisor and their company will take no responsibility for the advice. In fact, if your plan is ever sued, your adviser’s legal defense will be their recommendation was simply a sales pitch. The end result is their lawyers are arguing that you and your company are 100% and solely liable.

To know if you have a good adviser, ask the following questions. You can (and should) check out the adviser at BrokerCheck.org to verify their answers to the questions below and review their disciplinary record, if they have one.

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 their employer - with no fiduciary duty to you.

While most advisers will say they will do what is in your best interest, unless they are a Registered Investment Adviser, you have limited 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. An adviser holding only this license is paid by the client for the advice they give and doesn’t sell products on commission.

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. (With sales pitches often disguised as advice).

Do you take on the legal liability for the investment plan as an ERISA 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 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 to minimize your company’s liability for offering limited investment choices. It is important to realize that simply offering 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. The administrator/record keeper presents the biggest liability risk for your company if legally-required disclosures and timelines are not met. (Aside from extraordinarily high fees and outright fraud.)

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. Without skilled attorneys, the record keeper/administrator may not be 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 your plan complies with the law 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/administrator fee calculated?
Most record keepers/administrators charge a fee as a percentage of assets. While this is advantageous when the plan has little money 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.

Ideally, look for a fee mostly made up of a small flat-fee per employee and for the plan as a whole. This flat-fee structure 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 an ERISA 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 a significant reduction in 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 Broadridge, Charles Schwab, Fidelity, TD Ameritrade, and Vanguard. While there are many other good custodians beyond this limited list, you want to make sure the custodian isn’t an unknown company.

Ideally, the plan should use a third-party custodian rather than a captive custodian. This means the custodian, advisor, and the administrator/recordkeeper are all three different companies. This avoids the conflicts of interest and self-dealing that can be present when one firm employs all parties. Some firms, mine included, also use trust companies in combination with a third-party custodian custodian, which adds another layer of responsible parties.

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 investment losses. Many custodians will purchase additional private insurance to increase the protection for investors to amounts much higher than what 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. This allows employees to verify accuracy and reduces the chance of fraud.

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?
The custodian should actively be looking for fraud, embezzlement, and other criminal activities. Custodians should have extensive written policies and procedures for protecting your plan money.

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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. Your company owners and human resources leadership may also have personal liability related to the 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

This is the most common model for 401(k) plans. 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 fully liable for problems with the plan.

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 if 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 has 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 have fiduciary liability, which reduces the chance you will get advice which is 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 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 more likely to receive proper advice because the providers have taken on the fiduciary obligations and liability. 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

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, make recommendations, and demand they explain the reasoning behind decision. You can also 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.

| Request a Benchmark of Your Plan |

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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 a lesser standard (suitability standard or best interest 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 calling themselves Financial Advisers are held to the fiduciary standard, while the rest are held to the much lower standards as sales representatives (either suitability or best interest).

Fiduciary Standard

Being a fiduciary means the adviser owes a legal duty of loyalty to the client, must offer advice in the client’s best interest, and fully disclose and work to eliminate conflicts of interest. Fiduciary legal status provides significantly greater protection for your company and your employees compared to the lower Suitability or new Best Interest standard.

The importance of the difference in protection for you company 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 ‘Best Interest rule’ doesn’t hold brokers or insurance companies to a fiduciary standard.

Two Types of Fiduciaries

Advisers who hold the CFP or other certifications may call themselves fiduciaries, but 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 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 legally owe you a duty of loyalty and are required to do what is in your best interest, it is much easier to sue them for advice which harms 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. Stock brokers, insurance agents, and mutual fund company sales representatives are all held to the lower suitability standard.

The suitability standard states the adviser isn’t actually giving advice, but rather making a recommendation as part of a sales pitch. The recommendation 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 reasoning for the recommendation.

Further, advisers who are under the suitability standard don’t have a legal obligation to their clients. Instead, they have a legal obligation to do what is in the best interest of their employer, which is the insurance companies, the stock brokerage companies, or 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, it is unlikely you will prevail. The extremely low bar of the suitability standard means the adviser can get away with a lot of very questionable actions and recommendations.

The Best Interest Standard

In 2019, the SEC implemented the Best Interest Rule for broker/dealers and their sales agents. (If you can think of a major financial advising firm, chances are they are a broker/dealer or an insurance company.)

The SEC specifically avoided applying a fiduciary duty on broker dealers, even though they borrowed similar language which will create confusion for consumers.

As a result, many consumer advocates believe the rule was a hand-out to the financial services industry to help them avoid being subject to a fiduciary standard in the future. While the industry spent millions fighting the DOL’s true fiduciary standard, no lawsuits have been filed to fight the SEC’s watered-down Best Interest rule.

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. In this instance of being dually registered there is no true value to the fiduciary status of the adviser because they can (retroactively) decide the ‘advice’ was not subject to the fiduciary standard when they gave it.

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