What is ERISA Section 404(c) Compliance?
Why is ERISA Section 404(c) Compliance Critical?
As an employer offering a retirement plan, you are responsible for ensuring the investments your employees have to choose from are exceptional. Many liabilities and responsibilities come with this role. ERISA Section 404(c) compliance is crucial in reducing the liabilities of administering an employer-sponsored retirement plan. This is done by ensuring participants are responsible for their investment selection within the plan.
Section 404(c) of ERISA safeguards both plan sponsors and participants. To be 404(c) compliant, there are specific steps you'll need to take. This blog post is a guide for 401(k) plan fiduciaries. It explains the complexities of ERISA Section 404(c) compliance and the role of financial advisors in achieving and maintaining it.
Understanding ERISA Section 404(c)
Some plan administrators assume they don't have liability for investments participants select. To pass along investment selection responsibility to participants, plan administrators must set up the plan correctly and follow ERISA section 404(c). This does not remove the responsibility of plan sponsors from selecting and maintaining the fund lineup.
ERISA Section 404(c) offers fiduciaries certain protections if the plan grants participants control over their accounts. The provision aims to shield fiduciaries from liability for losses resulting from participants' investment decisions. However, to enjoy these protections, plan sponsors must adhere to specific requirements outlined in the regulation.
Key Compliance Elements
Here are ten questions to be answered when building an ERISA 404(c) compliant plan:
Can participants make investment decisions?
Are there three or more investment options available in the plan?
Are there at least three "core" investment options with significantly different risk and return characteristics?
Can participants allocate assets among the three core options in a way that allows them to achieve any prudent point on the risk/return spectrum?
Are the core investment options themselves diversified?
Is it allowed for participants to transfer in and out of each core option at least once a quarter?
Are participants permitted to move in and out of any option as often as required based on the expected volatility of the investment?
Does the plan provide at least three "core" investment options with significantly different risk and return characteristics?
Can participants switch to core options as easily as the most volatile option?
Has the plan provided the required disclosures?
Providing Adequate Information
Fiduciaries must ensure participants receive adequate information to make informed investment decisions. This includes offering details about investment options, risks, and historical performance. Collaborating with a knowledgeable 401(k) advisor or financial advisor specializing in retirement plans can help fiduciaries meet these disclosure requirements.
Many of the 404(c) disclosure requirements are similar to those in 404(a)5 Fee Disclosures. 404(a)5 fee disclosures are the required disclosures plan sponsors must give employees annually. They review the costs of participating in the plan.
404(c) disclosures disclose the following information:
The retirement plan intends to comply with ERISA 404(c).
Fiduciaries may be relieved of the liability of losses resulting from participant investment selections.
Diverse Investment Options
ERISA Section 404(c) emphasizes offering diverse investment options. Fiduciaries should work closely with financial advisors to design a well-rounded investment lineup. This investment lineup should cater to plan participants' varying risk tolerances and preferences.
It is not necessarily true that more investment options lead to better results. It is crucial to ensure that you offer only high-quality investment options. Some plan administrators provide a long list of investments. They hope that it will eliminate the need to choose the best investments.
If you are not confident selecting suitable investment options, consider hiring a 3(38) fiduciary. These professionals can manage the investment lineup for your 401(k) plan.
At CUI Wealth Management, our team of retirement plan financial advisors reviews 404(c) compliance requirements for our clients. This is part of our annual fiduciary checklist. We also act in a 3(38) fiduciary capacity for our clients, which relieves them of additional responsibilities.
Exercising Control and Direction
Participants must have the ability to exercise control and direction over their accounts. Fiduciaries should facilitate regular communication channels and educational resources, empowering participants to make informed decisions about their retirement investments.
Since participants make their own decisions, there must be a variety of investments. These investments must provide various risk levels. This way, participants have the best opportunity to diversify their investments according to their risk. This will give the greatest opportunity for savings for retirement.
Qualified Default Investment Alternatives (QDIAs)
Qualified Default Investment Alternatives (QDIAs) are investment options that retirement plan sponsors can designate as the default. This is for participants who do not actively choose an investment option.
The designation of a QDIA is crucial as it helps safeguard plan participants. It does this by keeping them from unintentionally remaining uninvested or holding assets in low-yielding investments. For example, It can automatically put participants into a target-date fund if they don't select another option.
When a QDIA investment accompanies ERISA 404(c) compliance, it offers additional protections to plan fiduciaries. ERISA 404(c) compliance places the investment direction responsibility on the participant. The QDIA allows for a default investment to be put in place when participants don't provide investment direction.
Most employees tend to remain in the default investment. Ensuring the default investments are selected through a well-designed process is critical. A wealth management advisor focusing on retirement plans can help you create a process for choosing suitable default investments. They can help you manage the QDIA selection process.
Monitoring and Reviewing Investment Options
Fiduciaries must establish a robust process for monitoring and reviewing the performance of investment options. This involves regularly assessing the lineup, removing underperforming options, and introducing new choices when necessary.
Establishing an investment committee and an Investment Policy Statement (IPS) to accompany the committee is best practice. Remember, the process is critical. Create a process and document the reasons for the decisions.
Financial advisors can be pivotal in conducting thorough investment reviews and offering recommendations. Our team can take on the 3(38) fiduciary status. This offloads the investment management process to our team.
Documenting Decisions
Proper documentation is critical to ERISA Section 404(c) compliance. Fiduciaries should maintain records of the decision-making process, including selecting and monitoring investment options. This documentation serves as evidence of prudent fiduciary practices.
We recommend creating and maintaining a fiduciary file. This fiduciary file should be shared with all employer-sponsored retirement plan decision-makers. Taking meeting minutes is a great place to start.
We take meeting minute notes for our clients during our ongoing meetings.
The Role of Financial Advisors
Experienced 401(k) advisors and financial advisors specializing in retirement plans can be invaluable partners. They can help fiduciaries navigate the complexities of ERISA Section 404(c) compliance.
Their expertise can assist in designing and implementing a comprehensive education program for participants, conducting regular investment reviews and providing insights into market trends, ensuring that all required disclosures are clear, accurate, and timely, and offering guidance on selecting and monitoring investment options.
Conclusion
ERISA Section 404(c) compliance is crucial to managing 401(k) plans and fulfilling fiduciary duties. Plan sponsors and fiduciaries can enhance their ability to meet these obligations by collaborating with knowledgeable 401(k) advisors and financial advisors.
By prioritizing participant education, diverse investment options, and diligent monitoring processes, fiduciaries can create a retirement plan that complies with regulations and empowers participants on their journey toward financial success.