401(k) Plans: With Great Power Comes Great Responsibility
Here are some important points employers should consider when offering 401(k) retirement plans.
A 401(k) retirement plan provides employers with a powerful tool to incentivize productivity and recruit and retain talent. With that tool, however, comes great responsibility to properly administer the plan. Here are some important points employers should consider when offering 401(k) retirement plans.
What is a traditional 401(k) plan and why use it? A traditional 401(k) plan is a retirement savings plan. At the request of the employee, the employer withholds pre-tax dollars from an employee’s pay check (up to $17,500 annually in 2014) and deposits that amount in a 401(k) account. The employer may also contribute to the employee’s account, sometimes even “matching” the employee’s contribution. Employees control how the money is invested, usually in a variety of mutual funds composed of stocks, bonds and money market investments. The accounts may earn interest, dividends or capital gains from investments that are not taxed until the money is withdrawn. The 401(k) withholdings also allow employees to decrease their taxable income.
Additionally, a 401(k) allows employees to contribute more than they could under an IRA plan. A 401(k) plan also benefits employers. Although employees are able to withdraw their own contributions prior to age 59 ½ (subject to a penalty), they can only withdraw the employer’s contributions after working at the company for a certain period of time. This prompts employees to stay at the company long-term. Employer contributions also benefit the employer because they are deductible on the employer’s federal income tax return, subject to certain limitations.
What is an employer’s liability for a 401(k) plan? Although employers can employ third-parties to administer the plan to try to minimize exposure, employers still owe plan participants fiduciary responsibilities of loyalty and prudence when establishing, amending or terminating a 401(k) plan. Employers are also required to review the plan administrator’s services, fees and investment offerings to determine if they are reasonable and appropriate for the plan and their employees. In these areas, employers must act solely in the interest of the plan participants and beneficiaries, namely the employees and carry out their duties with the care, skill, prudence and diligence that a reasonably prudent employer would exercise in similar circumstances.
A $13.4 million example. Failure to comport with these fiduciary duties can result in significant consequences for an employer. The 8th Circuit Court of Appeals recently affirmed the assessment of a $13.4 million judgment against an employer for failing to ascertain whether the plan administrator’s record keeping fees were reasonable, failing to negotiate lower fees and failing to use the plan fees to subsidize employer administrative costs unrelated to the plan. Importantly, an outside consulting firm notified the employer that it was overpaying for the administration of the 401(k) retirement plan, but the employer failed to act on that information. This example emphasizes the importance of ensuring that you are appropriately carrying out your fiduciary duties relative to plan administration.