Many plan sponsors get tangled in 401(k) rules and regulations, risking penalties and lawsuits.
By Carol Patton
Ever since the Revenue Act of 1978 introduced a provision, referred to as the Internal Revenue Code (IRC) Sec. 401(k), plan sponsors of 401(k) retirement plans have been treading in deep waters. Such plans are governed by complex federal rules and regulations that often baffle even the largest of plan sponsors.
While most mistakes made by plan sponsors are unintentional, federal courts aren't the forgiving type, requiring some employers to pay millions of dollars in damages. To avoid drowning, HR must reach out to legal and finance departments or consultants to jointly stay on top of changing laws, consistently monitor compliance, pay attention to record-keeper activities and never assume everything is under control.
Consider the adjustments New York-based Dial Global had to make. From 2001 to 2007, it served as plan sponsor of its 401(k) plan. The 11-year-old company, which produces and distributes radio programs to U.S. stations, could have gotten in over its head -- both financially and legally -- if it continued in that role, says Hiram Lazar, chief administrative officer at the 460-employee-nationwide company.
When Dial Global first launched, it only employed 40 people. The small staff didn't generate enough work for a full-time crew of retirement experts. Instead, Lazar says, the company formed a small investment committee whose members lacked experience in finance, retirement or investments. Committee members, his department and HR -- which reported to his department -- were guided by the company's record-keeper, Morgan Stanley, when arranging independent audits and selecting investment options.
But when Dial's workforce reached 100 employees, the cost of administering its 401(k), healthcare and other employee benefits continued to soar. Likewise, because the company was fiduciary of the plan, its responsibilities became more complex as new federal regulations were introduced.
Lazar began seeking more efficient ways to maintain and deliver employee benefits. Five years ago, the company joined forces with Insperity, a Houston-based provider of human resource and business-performance solutions. Lazar says his company saved roughly 40 percent in benefit and administration costs since Insperity buys employee benefits in volume for all of its clients, then passes along the cost savings. That said, Dial was still eager to turn over its fiduciary responsibilities as plan sponsor.
"It does concern me greatly that [a retirement benefit] I'm providing for employees . . . could potentially cause me tremendous damage if something's not done right," Lazar says. "Twenty years from now, people can have millions of dollars in their 401(k)s. If the fund gets messed up or something happens, they [can] sue me for millions of dollars . . . ."
He believes 401(k) plans offer tremendous risk for employers with very little reward. Still, if the company's workforce surpasses 1,000 employees, Lazar says, he suspects it may outgrow the economic advantages offered by its HR provider and hire in-house staff experienced in managing 401(k) plans.
Until then, he's relieved not to have to deal with numerous Employee Retirement Income Security Act laws and potential liability issues that could result from 401(k) mistakes.
"This is something I do not have to spend any time worrying about," says Lazar. "[401(k) plans are] just a huge risk on the employer side."
The Need to Monitor
As managing director of retirement services at Insperity, John Stanton says his own company and other plan sponsors can encounter a wide variety of problems regarding 401(k) plans.
The biggest mistake, he says, usually involves not monitoring employee distributions. Consider an employee who transfers from marketing to sales. If the transfer is not properly coded, it may appear as if the worker was terminated, which would inaccurately entitle him or her to a distribution.
Another area of concern involves medical hardships. "I've had instances where I had to deny hardship withdrawals because it wasn't for something that would meet the qualification," Stanton says, adding that he recently denied a withdrawal for rhinoplasty, which is a nose job. "It's a medical procedure, but isn't covered. . . . We had to make sure we did the proper research on it to make sure it was[n't], in fact, a hardship."
To ensure compliance, his staff routinely works with in-house legal and finance experts. He says three different federal agencies -- the Internal Revenue Service, the U.S. Department of Labor and the U.S. Securities and Exchange Commission -- can each influence the way 401(k) plans are administered.
If HR makes too many chronic and serious errors, watch out. Your company's retirement plan could be disqualified. Stanton compares that to dropping a nuclear bomb.
"Employers could face penalties of up to 40 percent of the plan's assets," he says. "That's why compliance is very huge. Most companies don't want to shell out [millions] . . . not having done things the right way."
While many mistakes are due to ignorance or misinterpretation of regulations, some plan sponsors get into trouble for doing nothing.
Consider the DOL's recent requirements for participant-fee disclosure, which improve transparency of fees. Many HR professionals believe they're in compliance and don't need to make any changes, says Mark Wayne, CEO at Freedom One Financial Group, a 401(k) plan adviser in Clarkston, Mich.
"We're hearing this quite often," he says. "It's very unusual for those disclosures not [to] be some catalyst for change."
Another example of the do-nothing approach involves plan fees. He says the only way to evaluate fees is through benchmarking.
Consider a 401(k) plan that charges participants 1 percent of their total account balance for record-keeping and other administrative costs. Maybe half of the fee represents administrative services. Through benchmarking, HR may discover that administrative services typically represent one-quarter of the total fee, not half, so participants are actually paying double for that particular service.
"[HR] isn't benchmarking at all or just looking at the top of the tree numbers saying their fees are good," says Wayne, explaining that they need to benchmark each fee, not just the total cost. "You have to look at the underlying pieces and compare apples to apples."
Perhaps no company understands this better than Zurich, Switzerland-based ABB Inc., a global manufacturer of power and automatic equipment. In March, a federal district court in Missouri found that ABB fiduciaries never calculated the amount of record-keeping fees paid to its provider (Fidelity), did not benchmark the cost of those fees and ignored its own consultant's advice that the fees were too high. In its ruling, Tussey vs. ABB Inc., the court delivered a very expensive lesson that day about fiduciary obligations, requiring the company to pay nearly $40 million in damages.
There are plenty of other ways HR can land in trouble. After designating a fund "bad" because of its inability to perform, some plan sponsors fail to take the extra step of informing employees to move their money out of the fund, or actually moving it for them.
"This is a trustee's job," says Wayne, adding that some employers falsely believe that an employee's permission is needed to transfer such funds. "If the employer doesn't move the money out and the fund amount drops, the employer can be sued and will lose, nine times out of 10. [Its case] will be dead on arrival."
Attention to Detail
Although 401(k) plans are audited every year, an independent compliance review is typically not done to the level and degree needed, which may result in an IRS audit and five- or six-figure violations, says Marina Edwards, senior consultant at global professional-services firm Towers Watson's Chicago office.
She says independent reviewers need to read the plan document and procedures manual from the record-keeper and test transactions to verify that they are synchronized and reconciled. Employers may pay penalties if, for example, after employees take a hardship withdrawal out of their 401(k) plan, their contributions aren't suspended for six months as required by the plan.
Problems can also erupt if compliance reviews aren't conducted between six and 12 months after changing record-keepers. She says auditors catch errors that are either passed down from the former vendor to the new one or are implemented by new providers.
One recent trend Edwards has noticed involves employers minimizing their liability by removing their company stock as an investment alternative in 401(k) plans. If the stock plunges, participants can sue the fiduciary of the plan, claiming it was not an appropriate investment. She says it has recently become a hot topic of participant lawsuits. In some cases, she says, employers are limiting the amount of company stock employees can hold in their account to between 10 percent and 20 percent.
Another problem area involves mutual funds as investment options. According to Edwards, such funds fall into different pricing categories. Some, for instance, require participants to pay fees when buying or selling them. The funds, she says, must be the lowest share class available, or the cheapest to purchase in their category for participants. The fiduciary committee must also assess the collective dollar amount in each mutual fund. The higher the balance, the higher the chance of buying the next cheaper share class, she says.
Edwards points to other pitfalls: HR not knowing if it needs to pay exit fees when changing record-keepers or not developing or following written processes for training members of the fiduciary committee.
"These are issues that almost all fiduciaries, regardless of plan size, need to pay attention to or be thoughtful about," says Edwards. "These are topics that I consult with Fortune 100 clients on every single week."