When a Committee of One Runs a 401(k)

Tax-qualified retirement plans run by small business owners must comply with ERISA—whether the sponsor is familiar with the landmark legislation or not.

For the small business owner, offering a retirement plan can feel like the right thing to do. But helping employees provide for their financial future is merely one duty a small business owner takes on.

According to professionals in the retirement field, most new sponsors of small or micro plans are unaware of the critical duties of prudence, loyalty and diversification of investments that a fiduciary to a plan assumes under the Employee Retirement Income Security Act (ERISA). Many are also unclear that the individual making plan-level decisions for a micro plan in essence becomes that plan’s management committee under ERISA—meaning he must perform many of the same responsibilities as the more robust and experienced committee of a mega plan.

How does an adviser best serve such clients, for whom the retirement plan is just another benefit to offer and not understood as the source of personal liability it potentially could be?

A good place to start is coming to a better understanding of the client. The typical small-plan committee is indeed made up only of the company owner, says Jim Sampson, founder and managing principal of Cornerstone Retirement Advisors. “He’s probably the salesperson, the service person, the accounting person, the maintenance person. He may work 80, 90 hours a week, and the 401(k) is an afterthought.”

Further, he is often “an owner who says, ‘I own this place, I’m just going to make the decisions.’” This arrangement may seem problematic, but it can actually be better for the company, as appointing other inexperienced employees to the plan committee exposes them to liability while accomplishing little, Sampson says. Many just rubberstamp the owner’s votes to avoid his displeasure. “One man, one vote” also quickens the management process, he says.

Barring a formal voting process, the small-plan committee takes the same steps any committee would, he says. They will follow the terms of the IPS and review the funds periodically. “They will still have to determine standards for when they’ll make a change: What are the criteria? What’s the time frame? They should still follow that process, and still document it like any other company or committee would. Just because it’s an investment committee of one doesn’t mean it doesn’t have to be prudent and do its due diligence,” he says.

More often than not, though, Sampson says, clients will say, “‘Hey, that’s what I hired you for.’” So communication around the basic tenants of the fiduciary duty remains important—as there are key limits to the amount of ERISA liability one can push off to a service provider, such as a fiduciary adviser.  

In general, many small businesses underestimate their fiduciary responsibility, he says. “They have the mindset: ‘Who’s going to bother me, with a plan that’s got only got a couple hundred thousand or a million dollars—they’re going after the big companies.’ There hasn’t been much to disprove that, but it only takes one.”

Craig Howell, business development specialist institutional with Ubiquity Retirement + Savings, formerly The Online 401(k), agrees that many clients are oblivious to ERISA’s demands. Ubiquity sells 401(k) plans and individual retirement plans (IRAs), mainly targeting startup companies. The average client has about five through 20 mainly white-collar, often IT, professionals. This group is often Web-savvy, but not investment-savvy—and they are often uninterested in changing that. 

“We have to put some specific rails in place to help those folks,” he says. “Fiduciary responsibilities are part and parcel of offering a 401(k) plan. But there are simple measures a small business owner can take to limit liability.” He suggests starting with “the basics,” first instructing business owners that they are fiduciaries and broadly what that means, also that they should follow their plan document; purchase a fidelity bond against losses; and ensure all fees are reasonable.”

Financial decisionmaking can and probably should be outsourced, though. Ubiquity advises hiring a 3(38) fiduciary manager to take on that function, freeing the owner to select and monitor the adviser, not the investments. The present time is especially favorable to engage a 3(38)’s services, Howell says.

“Technology is enabling managers to deliver their services in a really efficient way so that pricing—at least from our perspective—is really being compressed, and there are some fantastic deals out there, relative to even just a few years ago,” he explains. Citing figures of 10 to 25 basis points (bps), he says, this “insurance” is really inexpensive and probably well worth the price in most instances.

Jim Phillips, president of Retirement Resources, points to a void in formal communications—from either the Department of Labor (DOL), Internal Revenue Service (IRS) or vendors selling plan products—telling new 401(k) sponsors what ERISA’s demands are. Unless a vendor tells them, they may never hear it until they are blindsided by a plan audit, he says, adding that many small-plan sponsors are confused about their fiduciary role.

When opportunities arise, advisers can make a point to explain the facts. Phillips, for instance, discusses the topic at plan sponsor conferences and events. He, Sampson and Howell also recommend various free written resources such as the Department of Labor (DOL) website or T. Rowe Price’s guides on fiduciary compliance in running an ERISA-governed plan. Classes, too, such as those through the Plan Sponsor University, can be found online and in local colleges. Sampson, an adjunct lecturer has taught four such classes, but only one small business owner has yet to attend.

The free resources may suffice for day-to-day compliance, but when facing a complicated question and the small committee is unsure of what to do, it should seek professional guidance. Even just “a limited engagement,” Phillips says, could prevent a misunderstanding from becoming a lawsuit.

He also recommends short-term contracting with a good adviser “to build the plan governance, maybe a charter and an IPS, a compliance calendar, and provide them some training on how to fulfill their fiduciary duties and make suggestions for how to get better ultimate outcomes for participants.” This trial relationship might become long term when the owner discovers the benefits. “Besides avoiding trouble, if a plan is run more efficiently and is a better plan throughout, if the investments are more accessible, [this can increase assets in the plan,] which also benefits the employer,” he says.

Such relationships often do build and develop. “I find these folks great to work with, because they put a lot of trust in us—because they don’t have time to do it themselves or the experience,” Sampson says. “It goes back to ‘that’s what I hired you for—just do it.’ Not to mention that committee membership is stable. “We’re not dealing with a new committee member who wants to bring in his guy every three years or year and a half,” he says.