Fiduciary Risk in a Retirement Plan

As a plan sponsor of a 401(k) plan, it is crucial to understand fiduciary risk and how to manage it. Fiduciary risk is the risk of a plan sponsor being held liable for losses incurred by their 401(k) plan and its participants due to a breach of their fiduciary duties. Fiduciary risk is managed by taking a few key steps, such as establishing processes to ensure the plan is governed according to the law, engaging a qualified 401(k) advisor, and providing regular training and education for staff. By taking these steps, plan sponsors can effectively manage fiduciary risk and ensure the long-term success of their 401(k) plan.

What is a Fiduciary

Fiduciaries are individuals or entities entrusted with managing the assets and interests of others. As such, they bear a fiduciary duty to act in the best interests of their clients or beneficiaries.

As a 401(k) plan sponsor or administrator, you make decisions directly affecting your company's retirement plan participants. The plan design you choose, the investment options you allow, and the fees you decide to be reasonable are all decisions you make on behalf of the participating employees. Since your choices directly impact a participant's options and opportunities, and retirement plans are highly regulated, there are risks associated with your role.

What is Fiduciary Risk?

Fiduciary risk refers to the potential for financial harm, loss, or legal liabilities arising from a fiduciary's failure to fulfill its obligations faithfully. Fiduciaries must demonstrate high loyalty, care, skill, and diligence while managing the entrusted assets. Failure to meet fiduciary standards can result in adverse consequences, such as financial losses, reputational damage, and legal actions. 

Types of Fiduciary Risk

Operational risks

401(k) fiduciaries rely on various operational processes, systems, and infrastructure to fulfill their obligations. Operational risk encompasses the potential for disruptions, errors, or inefficiencies in these processes. This can include inadequate internal controls, data breaches, technological failures, or personnel misconduct. 

For example, a plan sponsor may fail to adequately monitor the activities of a 401(k) advisor, leading to potential financial losses for plan participants. This may be due to excessive fees, lack of experience, or imprudent investment recommendations. This is one of the reasons fiduciaries need to benchmark their financial advisor's fees and services regularly. 

Operational risks can also arise from internal errors, such as incorrect recordkeeping or improper handling of participant contributions. One of the most common examples we see when it comes to improper handling of participant contributions is late deferral deposits. 

To manage operational risks, plan sponsors must establish robust internal controls, implement regular monitoring processes, and assure compliance with applicable regulations and best practices. By addressing operational risks effectively, plan sponsors can help protect the interests of their participants and minimize potential liabilities.

Compliance risks

Compliance risks are another significant aspect of fiduciary risk. These risks arise from noncompliance with laws or regulations governing retirement plans. 

Fiduciaries operate within a regulatory framework that sets standards and guidelines for their conduct. Failure to follow regulations can result in legal and compliance risks. This includes noncompliance with reporting requirements, failure to adhere to fiduciary laws, or violating industry-specific rules.

For example, a plan sponsor may fail to meet the reporting and disclosure requirements mandated by the Employee Retirement Income Security Act (ERISA). This failure can result in penalties and legal consequences. 

Compliance risks can also stem from improper handling of participant data, such as failing to secure sensitive information or not providing timely disclosures to plan participants. To manage compliance risks, plan sponsors must stay updated on the latest regulatory requirements, maintain accurate records, and conduct regular internal audits to identify and rectify compliance gaps. 

By proactively addressing compliance risks, plan sponsors can ensure their retirement plans' legal and regulatory compliance, mitigating potential financial and reputational harm. Never assume other service providers are responsible for a given compliance item. It is best to take inventory of who is in charge of each responsibility and manage the plan systematically.  

Investment risks

Fiduciaries often make investment decisions on behalf of their clients or beneficiaries. While these decisions are based on careful analysis and expertise, they are not immune to market volatility and uncertainties. Investment risk arises when investments are not adequately monitored, leading to poor outcomes. 

Fiduciaries must ensure they have a process for selecting and monitoring investment options within a 401(k) plan. It is a common misconception that simply providing many investment options will relieve a fiduciary of the responsibility of prudent investment selection.

Don't assume other service providers are responsible for investment selection and monitoring. Often, a financial advisor will be utilized, and the plan sponsor assumes the advisor is taking on all investment selection responsibilities. Sometimes they don't realize their financial advisor may be taking on a 3(21) co-fiduciary role rather than a 3(38) investment management role in the retirement plan.

Managing Fiduciary Risk

Establish Processes

One of the first steps to establishing a process is understanding who is a fiduciary on the retirement plan and their responsibilities. It isn't easy to manage anything if you can't define it. It is also challenging to provide expectations to those who don't understand their role.

Once you have defined roles and responsibilities, you can implement policies and procedures to ensure the plan is compliant. Your 401(k) advisor, third-party administrator, recordkeeper, and ERISA council can help.

Your processes should include both due diligence processes as well as operational processes. It is vital to make good decisions and have supporting reasons. Both operational and due diligence procedures should be centered around ERISA compliance and keeping in mind the best interest of plan participants and their beneficiaries.

Monitor the Process

Having regular committee meetings to monitor your 401K is crucial. This allows you to review investments, discuss participant education needs, and ensure compliance items are delegated and completed promptly. The meeting minutes should be documented and kept in your fiduciary file.

Your financial advisor can have a critical role in the monitoring process. 401(k) advisors can help benchmark service providers, review investment policy statements, and help educate committee members. The financial advisor can also oversee meeting minutes and organize the fiduciary file. A good 401K visor can also provide insight into risks and potential plan design opportunities to improve the 401(k).

Training and Education

One common issue with 401(k)s is that people are often assigned to oversee the retirement plan without formal training. This is one of the reasons why people don't always make changes to their 401(k), even if they believe it may be mediocre. Having the proper training and education can be empowering for fiduciaries.

CUI Wealth Management provides monthly fiduciary education emails. Our goal is to help our clients have a better understanding of retirement plans and better understand their role. With this better understanding of retirement plans, our clients can make more informed decisions regarding their options.

Conclusion

There are several fiduciary risks associated with managing an employer-sponsored retirement plan. Some of these risks include operational, compliance, and investment risks. This list is not a comprehensive list of all the potential fiduciary risks. Some ways to reduce these risks include establishing and monitoring processes and continual education. We hope this helps you better understand what you can do today to mitigate such risks. We encourage you to talk to ERISA council if you have specific concerns. Our team at CUI Wealth Management can help you assess your retirement plan processes and provide guidance.