Mitigating Liability as a 401(k) Plan Sponsor: Your Role as a Fiduciary

29 Jan 2025 Mitigating Liability as a 401(k) Plan Sponsor: Your Role as a Fiduciary

Offering a 401(k) plan to your team is a meaningful way to invest in their future financial security. However, it also comes with a host of legal and administrative obligations. As a plan sponsor, you’re responsible for complying with regulations designed to protect your employee’s retirement savings and ensure prudent management of their investments.

Understanding these fiduciary duties can help you minimize liability, stay compliant, and safeguard your employees’ retirement assets.

The basics of fiduciary responsibility

The moment you establish a 401(k) plan, you assume fiduciary responsibilities under the Employee Retirement Income Security Act of 1974 (ERISA). This means you must act in the best interests of your employees and their beneficiaries. Failing to manage the plan prudently, comply with regulations, or address employees’ financial needs can expose you to significant liability.

Some plan sponsors mistakenly believe that hiring third-party service providers relieves them of all fiduciary duties. However, ERISA requires active oversight of these providers and careful decision-making on your part. Even if you delegate specific tasks, you retain ultimate responsibility for selecting and monitoring those service providers.

Fiduciary responsibility: what it means

ERISA broadly defines a fiduciary as anyone who exercises discretionary control or authority over the management or administration of a plan or its assets or who gives investment advice for a fee. This generally includes the plan sponsor, administrator, advisors, and investment managers. For the purposes of this article, we’re focusing on sponsors—the employers—and what you need to know to fulfill your responsibilities.

The plan administrator (sometimes the employer or a designated third party) oversees daily operations. This includes filing the necessary forms, providing timely participant notices, and maintaining plan records. Even if you outsource administration to a third party, you must ensure everything meets regulatory requirements. Inadequate oversight of plan operations could result in costly mistakes, including late filings, missing disclosures, and fines from government agencies.

Fiduciaries can also be “named” in the plan documents (such as the employer or investment manager) or “unnamed” by virtue of their actions (someone who effectively controls the plan’s decisions, even if not officially designated). Ultimately, if you or anyone in your organization has the power to influence the plan, that individual can be considered a fiduciary.

Core fiduciary duties under ERISA

Regardless of the number of fiduciaries involved, each must adhere to these key responsibilities:

• Acting in the participants’ best interests

• Performing duties prudently and with sufficient expertise

• Following the plan documents and policies

• Diversifying plan investments

• Keeping plan expenses reasonable

At first glance, these requirements might seem vague. However, these rules have been in place long enough that there’s substantial guidance on how to interpret and apply them.

Common pitfalls and best practices for managing them

Even with diligent oversight, plan sponsors can face challenges that put compliance and employee retirement savings at risk. Below are some of the most frequent pitfalls sponsors encounter, along with best practices to address them effectively.

Insufficient oversight of service providers

Failing to properly monitor administrators, recordkeepers, or other third-party service providers can lead to regulatory violations or costly mistakes. Many sponsors assume that outsourcing absolves them of responsibility, but sponsors are required to oversee the performance of any providers they hire.

It’s important to establish a structured process for reviewing your service providers’ performance regularly. Schedule periodic evaluations to ensure they meet expectations and review contracts to confirm fees remain reasonable. Clear documentation of your oversight efforts will also demonstrate compliance during audits or regulatory reviews.

Recordkeeping Errors

Missing or inaccurate records—particularly for loans, hardship withdrawals, or contribution tracking—can lead to compliance issues and penalties. Poor documentation can also create unnecessary challenges during regulatory audits.

Maintain thorough, well-organized records for all aspects of plan administration, including meeting minutes, plan amendments, and loan documentation. Regularly audit your records to ensure they are complete and up to date. Use automated systems where possible to reduce manual errors and ensure consistency.

Misunderstood compensation definitions

Plan sponsors often miscalculate contributions due to unclear or incorrect definitions of compensation, such as excluding bonuses or overtime from eligible earnings.

Work with payroll and HR teams to clarify how compensation is defined in your plan documents and ensure systems are aligned to calculate contributions correctly. When necessary, consult experts to confirm compliance with IRS rules. Regular audits of payroll processes can help identify and address potential issues early.

Nondiscrimination testing failures

Plans that disproportionately benefit highly compensated employees may fail nondiscrimination tests, leading to penalties or required corrective contributions. Low participation rates among rank-and-file employees often exacerbate this issue.

Encourage broader employee participation by offering education sessions about the plan’s benefits, emphasizing matching contributions, or introducing automatic enrollment features. These steps can help create a more balanced plan and reduce the risk of failing nondiscrimination tests.

Delayed contributions

Delays in depositing employee deferrals can result in penalties from the Department of Labor (DOL), including the requirement to compensate participants for lost earnings. Even minor delays can trigger scrutiny.

Synchronize your payroll systems with the plan’s records to ensure timely deposits of employee contributions. Set up automated processes wherever possible to minimize delays. Conduct regular checks to verify contributions are being deposited within the required timeframes.

Audits, compliance, and regulatory changes

Plans with more than 100 participants typically undergo an external audit each year, which scrutinizes financial reporting and compliance practices.

The participant count is now based on the number of participants with account balances rather than just those who are “eligible.” This change took effect for the 2024 plan year and is intended to reduce the burden on plans where many workers may be eligible to participate but don’t maintain an active balance.

Even if an audit is not mandated, performing occasional internal or external reviews can reveal issues such as improper fees or administrative oversights before they become major problems.

Preparing for DOL or IRS Examinations

Regulatory agencies often examine plans for missing documentation, incorrect plan definitions, and oversight failures. Plans that have kept comprehensive records acted promptly to fix issues and documented each important decision tend to fare better in these reviews. The DOL and IRS also encourage sponsors to self-correct or voluntarily disclose errors to secure more lenient treatment and reduced penalties.

Voluntary correction programs and self-reporting

Errors can and do happen, particularly if you manage a large plan or rely on multiple service providers. Both the IRS and the DOL have established programs allowing plan sponsors to report and fix mistakes before they escalate, typically resulting in reduced fees or no penalty at all. Proactive reviews—ideally yearly or semi-annually—are often the easiest way to catch potential issues. Self-correction not only saves money but also demonstrates your intention to prioritize the plan’s health and function.

Staying compliant

Sponsoring a 401(k) plan is a valuable benefit for your employees and a serious legal and ethical responsibility. While these duties can feel daunting, the good news is that you don’t have to manage them alone.

Outsourcing key responsibilities to professionals can significantly reduce your burden. These experts bring the necessary expertise to handle the complexities of investment decisions, plan administration, and compliance. However, it’s important to remember that outsourcing doesn’t absolve you of all liability; you retain the responsibility to select and monitor these professionals carefully.

By staying informed, establishing strong internal controls, and relying on seasoned experts where appropriate, you can confidently meet your fiduciary obligations while safeguarding your employees’ retirement savings.

This article is for informational purposes only and should not be considered legal advice. If you have specific questions or concerns about your 401(k) plan, consult with a qualified professional to ensure compliance and protect your organization and your employees.

Contact The Haynie & Company CPA Firm For Tax Advisor Services