401(k) Plans: The Early Days, ERISA and Your Fiduciary Responsibility
small business retirement plans

December 18, 2014  |  

401(k) Plans: The Early Days, ERISA and Your Fiduciary Responsibility

Third in a series of articles about retirement plan costs for investors, business owners and plan administrators401k

Key Takeaways

  • The Employee Retirement Income Security Act of 1974 (ERISA) put in place guidelines to help protect retirement plan participants.
  • The 401(k) plan, although a relatively new concept, has become the primary retirement savings vehicle for today’s investor.
  • Having a fiduciary helps to ensures that the interests of plan participants are placed first.

In this article, we will talk about ERISA and the seismic shift in fiduciary responsibility. We will explore how 401(k) plans come to prominence as well as the impact that the demographic bulge of retiring baby boomers is having on retirement plans, the biggest myths and misconceptions about savings goals and the many types of plans.

ERISA and your fiduciary responsibility

The Employee Retirement Income Security Act of 1974 (ERISA) requires employers to follow certain rules for managing 401(k) plans. Employers are held to a high standard of care and diligence and must discharge their duties solely in the interest of the plan participants and their beneficiaries. This is known as being a “fiduciary.” Among other things, being a fiduciary means that employers must:

  • Establish a prudent process for selecting investment options and service providers
  • Ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided
  • Select investment options that are prudent and adequately diversified
  • Disclose plan, investment and fee information to participants to make informed decisions regarding their investment options under the plan and
  • Monitor investment options and service providers once selected to see that they continue to be appropriate choices for their current and former employees

Not your grandfather’s 401(k) plan

In an effort to bring more transparency to 401(k) plan fees, legislation was enacted in 2012 requiring specific disclosure of retirement plan fees. The 408(b)(2) participant fee disclosure and the 405(c)(3) plan-level fee disclosure documents provide important details about underlying fund costs, transaction fees, platform expenses and a myriad of other plan-related costs. Historically, many of the costs associated with 401(k) plan fees have been “hidden” or “soft-dollar” costs. This means that the costs are deducted or otherwise obtained in a manner in which you do not actually see transactions coming out of your account to pay for them.  By comparison, “hard-dollar” costs are those for which a tangible financial transaction has occurred, such as writing a check, transferring funds, or charging a debit to your account.

Since the financial crisis, the term “fiduciary liability” has come under the spotlight as we hear countless stories of 401(k) plan participants losing their retirement savings because they were either ill-informed, or because they invested in unsuitable strategies, or both. Employers (plan sponsors) have a fiduciary duty to their employees to ensure that employees have access to suitable investments and that they are sufficiently educated about their choices. With this duty comes not only tremendous responsibility, but liability as well. The good news is that, under the right structure, plan sponsors can “shift” this liability to an investment manager who is authorized to act as a 3(38) fiduciary.

Why your advisor should be a 3(38) fiduciary

Using a financial advisor who can act as a 3(38) fiduciary can greatly reduce this liability. As a Registered Investment Advisor (RIA) and as a 3(38) Investment Manager, our firm helps plan sponsors mitigate fiduciary risk so they can focus their time and effort on running their businesses. A 3(38) fiduciary can only be (a) a bank, (b) an insurance company, or (c) a registered investment adviser that is subject to the Investment Advisers Act of 1940. If you’re not sure that you’re getting this fiduciary, check to see if your plan pays commissions to a brokerage firm. If you are paying commissions, then you are not getting 3(38) fiduciary coverage.

In one plan that our firm recently evaluated, not only did we reduce the plan-level costs by more than $100,000 dollars a year, we dramatically improved the cost structure and investment diversification at the participant level. We accomplished this without sacrificing investment performance. How? By using low-cost passively managed mutual funds and by providing “model” portfolios that are professionally managed.

A quick history of 401(k)s

We tend to think of 401(k) plans as the bedrock of the retirement savings system. But these plans, named after a section in the Internal Revenue Code, were developed more by accident than by design. When lawmakers originally established the Revenue Act of 1978, the goal was to prevent executives at some companies from having too much access to the perks of cash-deferred plans. Why? Well since the 1950s, companies had have been fighting with the Internal Revenue Service (IRS) to allow more money to be squirreled away in such plans.

The accidental birth of the 401(k) can be attributed to a benefits consultant named Ted Benna. In 1980, Benna used his interpretation of the 1978 Act to create a 401(k) plan for his own employer, The Johnson Companies, that allowed full-time employees to fund their accounts with pre-tax dollars and matching contributions from their employer. Benna then asked the IRS to change some proposed rules under the law that ultimately led to employers’ widespread adoption of 401(k) in the early 1980s.

“I knew it was going to be big, but I was certainly not anticipating that it would be the primary way people would be accumulating money for retirement 30-plus years later,” Benna, now semi-retired and the president of the 401(k) Association, told Workforce magazine in a 2013 interview.

From their humble beginnings in the early 1980’s, 401(k) plans have come a very long way. In the beginning, only a handful of very large companies offered them such as Hughes Aircraft, Johnson & Johnson, FMC, PepsiCo, JC Penney and Honeywell to name a few.  Today, nearly 95 percent of private companies offer 401(k) plans to their employees.  As of 2013, over 51 million 401(k) plan participants had more than $3.5 trillion invested in their plans.

In addition to growing in popularity (and assets under management), 401(k)s have undergone structural changes since the early days as well.  A few of the most significant changes are:

  • The Tax Reform Act of 1984 (TRA ‘84) changed the rules to require nondiscrimination testing so that highly compensated employees don’t receive an unfair advantage versus rank and file employees.
  • Annual deferral limits have been increased and the amounts are now indexed for inflation so that they will continue to increase. ($17,500 for 2014)
  • The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) allowed for “catch-up” contributions giving individuals at least 50 years old the ability to save amounts beyond the standard deferral limit. ($5,500 for 2014)
  • EGTRRA also provided for the creation of Roth 401(k)s allowing after-tax contributions to grow completely tax free.


401(k) plans are one of the most powerful retirement savings plans available today and one of the most attractive employee benefits a company can offer its workers. Whether you are a plan sponsor or individual participant, my hope for you upon completion of this article series is that you will be armed with enough information to make informed decisions about your financial future.  At minimum I want you to walk away knowing what questions to ask in order to ensure that your costs are reasonable, you are properly diversified, and you understand where to focus your efforts for maximum effect.

In our next installment we’ll explore the different types of defined contribution plans available today, as well as their cost structures and suitability for different types of investors.

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES
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