Many executives only think of their 401(k) when receiving a plan financial statement. They don’t consider plan operations, potential pitfalls or their basic duties in operating plans. A set of recently released regulations is systematically forcing that mindset to change.
Plan sponsors’ and fiduciaries’ duties to a plan and its participants were clarified by the new regulations. Patrick M. Shelton, GBA, managing member of Benefit Plans Plus, LLC, says, “Legally, plan sponsors are now required to have intimate knowledge of and communicate specific plan information to participants. If they fail to do so, they could face regulatory penalties, legal action from employees or get embroiled in class-action lawsuits.” He says most information must be communicated at least annually to participants, even those who have left the company but still have plan balances.
Smart Business spoke with Shelton about plan regulations and the critical importance of “benchmarking.”
What is the key determination?
Under federal law, plan fiduciaries must act ‘prudently’ and ‘solely in the interest of plan participants and beneficiaries’ to ensure a plan pays covered service providers (CSP) no more than ‘reasonable’ fees. Sponsors must review and understand all plan fees and then formally communicate them. While costs are important, they are not the only consideration. Lowest cost is rarely a determination of a well-run and effective 401(k) plan.
What are the new regulations?
Regulations are under section 408(b)(2) of the Employee Retirement Income Security Act (ERISA) and are designed to help plan fiduciaries ensure that plan service arrangements are ‘reasonable.’
The regulations impose a duty on every plan CSP to provide information to plan fiduciaries necessary for them to assess the reasonableness of CSP compensation, identify potential conflicts of interest, and satisfy reporting and disclosure requirements.
ERISA section 404(a)(5) regulations require fiduciaries — of plans allowing participant directed investments — to provide specific information designed to enable participants to make informed investment decisions. General plan and administrative and individual expense information are required.
What is benchmarking and how can it help determine ‘reasonableness’?
Benchmarking is a process for compiling and comparing plan data to plans with similar design and demographics. Data might include plan design, including its underlying details, eligibility requirements, benefit or contribution formulas; assets; direct and indirect administrative costs; investment choices; compliance; and performance.
Benchmarking simply assists fiduciaries in determining a basis for reasonable fees. If fees are higher than average for similar-sized plans, there should be a clear explanation of why more is being paid.
What are some best practices?
You should benchmark your plan every three to four years, recognizing that the costs of professional reviews vary widely from $1,500 to $25,000. You should use benchmarking services that provide relevant data and rotate service providers to vary the results and avoid biases. You should also ask about the methodology to ensure you get valid information. In addition, you should maintain results in a file where all 401(k)-related information is readily accessible and periodically review the results and form an action plan to bring your plan in line with company philosophy and values.
Most benchmarking providers don’t adjust their comparisons by region and often extract unfiltered data from public sources. Further, while more plan data is becoming available, currently there’s not strong benchmarking data for small plans, or those with fewer than 100 participants.
What happens if you’re out of compliance?
Plan sponsors and fiduciaries are personally liable for any failure to procure the required information from CSPs. However, the regulations contain a ‘safe harbor’ method of complying — shifting responsibility to non-compliant CSPs and notifying authorities. In most cases, CSPs provide disclosures on a quarterly and annual basis that are designed to be compliant with all of the rules.
Patrick M. Shelton, GBA, is managing member at Benefit Plans Plus, LLC Reach him at (314) 824-5252 or [email protected]
For more information regarding fiduciary responsibilities, visit www.bpp401k.com/fiduciary-health-check.