Employers often ask "do I need a 401(k) advisor" and "what is a 401(k) fiduciary"? A 2022 survey found that 87% employers felt that having a financial advisors improved retirement outcomes and a whopping 95% felt that fees were worth the cost. But before you hire a financial advisor to help with your small business 401(k) plan, it is important to find out whether they will act as a fiduciary, and if so what type?
To help you make sense of their response, we sat down with Carol Buckmann, an ERISA attorney who’s spent over 35 years helping hundreds of 401(k) plan sponsors navigate their fiduciary responsibilities.
We got answers to the most common questions, plus Carol’s insider perspective on fiduciaries, the “401(k) lawsuit boom”, and how a 3(38) fiduciary can help you outsource both your financial risk and your investment responsibilities.
Ready to get the answers? Let’s start with...
What exactly is a fiduciary?
“This is a question a lot of plan sponsors are uncertain about. In fact, according to a JP Morgan survey, 43% of company fiduciaries don’t think they’re fiduciaries.”
That’s right. You can be a fiduciary for your plan without knowing it. Often because there’s confusion about what exactly a fiduciary is.
So here’s a quick explanation:
ERISA defines a fiduciary as a person involved with plan administration, a person with management and control over investments, or a person who gives investment advice regarding plan assets.
Essentially, if you’re responsible for some level of 401(k) plan management or oversight, you’re probably a fiduciary. Which means you have a legal obligation to act solely in the best interests of the plan participants.
As Carol points out, “The Employee Retirement Income Security Act (ERISA) says every plan must have at least one named fiduciary… If no one is specified as the default named fiduciary in the plan documents, the business owner or the board is on the hook.”
We’ll get into what “on the hook” can look like in a little bit. But first:
What does a fiduciary do in a retirement plan?
The short answer is: a lot. Managing retirement plan investments and administration is no simple task. And being responsible for investment decisions is a heavy burden on its own.
“The fiduciary is the individual or entity responsible for ensuring the plan’s fund lineup is optimized in the best interests of participants. Generally this means it’s diversified, free of poor-performing funds, and fees are reasonable.”
Naturally, fulfilling your duties as a fiduciary can be a lot of work. Some of the top investment responsibilities include:
And that just covers the investment fiduciary obligations. Plan fiduciaries are also responsible for ensuring that day-to-day administration complies with the plan documents and ERISA.
As Carol mentions, this work really adds up. “It’s about the equivalent of a part time job. You have to hold committee meetings. And with any meeting comes time spent preparing as well. Then you have to deal with administrative issues, claims, appeals… so if you’re not devoting a certain number of hours each month, you’re probably not fulfilling your responsibilities correctly.”
And if those responsibilities aren’t being fulfilled… you can be the target of a lawsuit. A point the Department of Labor makes clear in a Fiduciary Handbook: "With these fiduciary responsibilities, there is also potential liability. Fiduciaries... may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions."
Recognizing that many small businesses don't have sufficient resources or expertise to manage all aspects of the plans themselves, ERISA does allow employers to delegate both the work and liability to service providers: "A fiduciary can also hire a service provider or providers to handle fiduciary functions, setting up the agreement so that the person or entity then assumes liability for those functions."
Types of investment fiduciaries: 3(21) vs. 3(38)
Named for the sections of ERISA which define them, 3(21) and 3(38) fiduciaries are both individuals or entities that provide investment expertise to 401(k) plan sponsors.
And yet, the services of these similarly-named fiduciaries and the level of protection they provide are quite different:
“A 3(21) fiduciary is an investment adviser and ‘co-fiduciary’ with the company fiduciary (business owner, board, or named fiduciary). They provide investment recommendations on how to build the fund lineup and monitor the investment options. But they don’t have any decision-making or discretionary authority. It would still be the company fiduciary who’d make the actual decisions, which means the company fiduciary is still liable for fees and performance.”
In short, while a 3(21) fiduciary may provide you advice on what to do, you decide whether to implement their advice. If you followed bad advice, you will share the liability with your 3(21) fiduciary.
3(38) Fiduciary - Transfer responsibility & liability
“3(38) fiduciaries are different. You can delegate most your responsibility to an investment manager. A 3(38) will actually make the decisions about what to include in the plan menu, implement it, and then manage the investments on an ongoing basis.”
The most important differences come down to risk and responsibility. As Carol points out, a 3(21) fiduciary acts as an investment advisor who does some of the work and makes recommendations.
By contrast, a 3(38) is an investment manager. Which means they handle the work, review investment options, make decisions, and ultimately take responsibility for your plan’s day-to-day investments.
Because the full differences in these fiduciary service providers can get a little convoluted, we laid them out in a helpful table:
Now, with all that information under your belt, you may be wondering...
Wait, so that means my employees can sue me for high fees or poor investment performance?
That’s right. Poor performance or high fees can be grounds for litigation. And it happens more than you think.
According to Carol, “It happens all the time. Nearly every day, I see headlines in Bloomberg or Benefitslink about another multi-million dollar 401(k) award or settlement... The number of cases is just staggering.”
Those near-daily headlines really add up. Since 2009, shortly before the Department of Labor started requiring providers to more clearly disclose their fees via the 408(b)(2) rule, roughly 83,000 ERISA lawsuits have been filed in federal district courts.
Plans suffering from high fees or poor investment returns are common enough that they’ve given rise to their own litigation industry. There are countless law firms offering ERISA litigation services.
Just try googling ‘ERISA litigation’ and you’ll see what we mean - a ton of websites calling for participants to contact them about possible fiduciary breaches and/or submit their fee disclosures.
After all, attorneys can make a lot of money through ERISA litigation. Even if the cases don’t go to trial.
And with so many plan sponsors unaware of their fiduciary responsibilities or what they need to do to fulfill them (reminder: 43%), it's no wonder this type of litigation is booming.
Carol warns that “Some of the settlements in this 401(k) litigation have been around $50 million. There have been huge awards by the courts. The exposure there, if you’re found liable for fiduciary breach, can be extensive. It’s personal liability too.”
Depending on your resources and experience, that personal liability can be a pretty heavy burden - one that you might want to share with or shift to someone else. An investment advisor can help you with that.
How can an investment advisor service help mitigate this risk?
An investment advisor or manager can take much of your fiduciary responsibility off your plate by acting as a named investment co-fiduciary for your business’ retirement plan (just be sure to get that co-fiduciary acknowledgment in writing).
Sometimes, not only is it prudent to go the “investment advice” route, it might even be required. As Carol points out: “ERISA actually has a pretty advanced standard that’s called the Prudent Expert Standard… You’re supposed to hire experts when you’re not qualified. Unless there’s internal expertise at the plan sponsor level, it’s your responsibility to consult with an expert.”
Basically, if you’re not 100% confident that you have the know-how to manage long-term investments like a financial advisor, “You need to pay for good [fiduciary] services. If you don’t, you could end up being liable for a lot more for not doing the job properly.”
Regardless of your expertise though, a fiduciary can be a fantastic idea. You can look forward to reduced risk and management responsibility, more time (and brainpower) to spend on more impactful business concerns, and general peace of mind.
But not all fiduciaries are created equal. ERISA allows for businesses to hire two classes of investment fiduciaries: the 3(21) and the 3(38).
3(21) vs. 3(38) Fiduciary… which of these options is right for me?
There’s no need for this to be more complicated than it already is. Making the choice between a 3(38) and 3(21) fiduciary comes down to a few considerations:
Get a 3(38) Fiduciary if…
You are too busy to take on what is essentially a part-time job.
You don’t have someone internally with the required level of expertise. (Remember that “prudent expert” standard. Business finance experience like a CFO might have is not the same as ERISA or investment management knowledge).
You want the maximum fiduciary protection possible.
You want to focus your time and resources on running your business. Not selecting and monitoring investment options.
Basically, if you’re not looking forward to managing your retirement plan investments, you’re comfortable giving up day-to-day control, and you’d rather focus on running your business, we recommend hiring a 3(38) fiduciary.
On the other hand:
Get a 3(21) Fiduciary if…
You have the time & investment expertise needed to meet regularly, monitor investment performance, listen to 3(21)’s recommendations, and come to independent decisions.
You prefer to be actively involved in managing the plan’s investments and don't mind taking on the risk of how your investment decisions may impact your employees.
You’re okay with having the ultimate liability for fees and investment performance.
You can think of a 3(21) as the “Lite” type of a fiduciary role. If all you’re looking for is someone to offer guidance and make recommendations and your fine shouldering investment liability, a 3(21) might be the best option for you.
Cons of3(21) Fiduciaries
Here’s a final word of warning: “You can’t blindly follow the recommendations of the 3(21) advisor. You have to make an independent decision, and though that’s usually what the advisor recommends, you’re not excused from making an informed decision just because the advisor recommended it.”
In fact, there have been several legal cases in which the defense was shot down after claiming that they were just following the recommendations of their 3(21).
Keep in mind, regardless of who you hire, you still have to pay attention to the plan. Even a 3(38) will not completely protect you from all liability and potential litigation. As plan sponsor, you’re always responsible for overseeing the providers that you have engaged to help mitigate your fiduciary liability.
You don’t get told about the tremendous level of risk that you take on as the plan fiduciary when you start a 401(k).Throughout our interview, Carol’s insight revealed a litigation landscape littered with the lawsuits of plan sponsors who didn’t do their due diligence.
Thankfully, as convoluted as ERISA can sometimes seem, the fiduciary options it lays out help businesses pick a fiduciary that works best for them, whether that’s a 100% DIY solution, consulting a 3(21), or delegating to a 3(38).
If what you’ve read has you considering a 3(38) fiduciary, consider a tech-enabled one! At ForUsAll, we combine technology with a team of dedicated ERISA experts to automate plan administration, engage your employees, and ultimately build a 401(k) that gives you and your employees a good shot at a comfortable retirement.
Carol Buckmann is a founding partner at Cohen & Buckmann PC, a boutique law firm practicing exclusively in the areas of employee benefits, executive compensation and investment adviser law. Prior to co-founding Cohen & Buckmann PC, Carol practiced at major law firms for over 30 years, advising about all aspects of employee benefits and compensation, including fiduciary advice, plan qualification and executive compensation. Carol frequently blogs, writes articles and is quoted in the media about current employee benefit issues.
Go beyond a basic 401(k)
Give your employees more than just a 401(k), join the movement.
David Ramirez, CFA, is a recognized 401(k) expert with over 20 years of experience in 401(k), ERISA, cash balance plans, and ESOPs. A UC Berkeley graduate, he played a pivotal role at Financial Engines, a 401(k) advisory firm founded by Nobel Laureate William Sharpe, Ph.D., where he was a portfolio manager who helped manage over $50B in 401(k) assets. His clients included some of the largest Fortune 500 companies and state governments.
Go beyond a basic 401(k)
Give your employees more than just a 401(k), join the movement.